Critical Fundamental Themes to Keep Watch For Next Week:

• Volatility Slipping Back into Habit of Complacency as Liquidity Fills [Indices, VIX]
• US-China Trade War – Beyond the Point of De-Escalation? [AUDUSD, USDCNH, Indices] 
• A Climb in Risk Appetite as More Fundamentals Fall Away [S&P 500, Dow]
• Recession Warnings In the Market Converging with Those in Data [Indices, Yields, Gold] 
• Monetary Policy Ability to Stabilize Growth, Markets [EURUS, ECB, Fed, BOJ, Gold]
• Politics Increasingly Core to Market Outlook [S&P 500, Yields, Gold]
• Natural Growth Versus Monetary and Fiscal Stimulus-Led Growth [Indices, Dollar, Gold]
• UK PM Johnson – Parliament Fight Over No-Deal Cliff on Oct 31st [GBPUSD, EURGBP, FTSE100]
• US $7.5 Bln in WTO-Approved Tariffs Threatens US-EU Trade War + General Auto Tariffs Back to November [EURUSD, USDJPY, USDMXN, USDCAD]
• The Threat of Currency Wars [EURUSD, USDJPY, USDCNH, Risk Assets]
• Gov’t Bond Yields and Commodities as a Growth-Leaning Risk Asset [Dollar, Euro, Yields, Oil]
• Specific Safe Havens: Dollar, Treasuries, Gold, Yen [Dollar, EURUSD, GBPUSD, USDJPY, Gold]
• Excessive Leverage / Debt in Public and Private Channels [S&P 500, Yields, Gold]
   

US-China Trade Progress: The Boy Who Cried ‘Progress’ 

My favorite flawed, risk benchmark in the United States S&P 500 index jumped to a record high through the end of this past week. A technicians overview would suggest that intensity of a gap higher, a daily candle that opened on the low and closed on the high as well as the clearance of a long-term rising wedge top added considerable luster to an already momentous achievement. It wasn’t a stretch to assign this thrust – shared by most risk-leaning assets – to either a general state of speculative complacency or perceived improvement in US-Chinese trade relationships (I believe it is a combination of both). After a few swings in rhetoric this past week, investors were bequeathed a rare perspective of enthusiasm in negotiations into the weekend. The headline that charged bulls reported on Chinese sources remarking that the two sides had reached a “consensus in principle” on the ’Phase One’ deal. 

It is important that this perspective would come from China rather than the US. Beijing has been the most dubious of its counterpart’s intent and commitment since the Washington changed direction dramatically following the G-20 meeting where both sides seemed to have struck an accord. The reported breakthrough in this first stage deal would requires China to purchase US agricultural goods, open financial services markets to US companies and maintain stability behind the Yuan (ironically, what would be technical manipulation). On the other hand China requires the US to ensure it is dropping the planned tariff escalation – to encompass essentially all of the country’s goods – on December 15th. 

If we see this effort move forward, it would indeed offer a significant measure of relief. How would we judge a step in the right direction without President’s Trump and Xi signing on a finished plan? An official date and time for a summit would represent a tangible milestone for intent. Yet, as important as it is to ease back on the accelerator of growth-killing trade restrictions, we should not treat this as a wellspring of untapped growth. This is avoiding greater pain. To fully de-escalate, we would theoretically need to see the passage of the ‘Phase Two’ which would have far more difficult requirements to agree upon. Agreement would need to be found on intellectual property rights, enforcement, state run enterprises and the full reversal of the onerous tariffs applied to this point. That is a high hill to climb for two countries that are attempting to use their size and position to avoid capitulation. Against this backdrop, we need to consider just how much lift such a first step deserves for something like US equities where it is technically already pricing in perfection. 

A More Extreme Signal of Risk Appetite Than SPX Record: Record Short VIX Interest 

I am a considerable skeptic when it comes to the record highs the major US equity indices reflect. From a landscape perspective, the S&P 500, Dow and Nasdaq are significantly higher that global equity counterparts and pushing far greater excess relative to alternative asset types with a risk connection. While you could point to relative yield, an assumption of growth or perhaps an element of safety in US assets; it is more than a stretch to afford this degree of premium relative to counterparts. Furthermore, speculative measures are broadly running far afield of traditional measures of value. We would expect peak growth, peak earnings and/or peak yield to push record highs on capital measures. We are far, far from those milestones. Yet, here we find ourselves. That is the biproduct of speculative conviction/complacency, growing leverage, extremely generous monetary policy and no small assumption that fiscal support will offer a backstop should the other two nodes fail. Should these joists of risk appetite be truly tested, it is very unlikely to hold up. 

Yet, as we track the fundamental weather between economic health updates, trade wars and monetary policy effectiveness; we are also finding optimists latching on to familiar runs such as seasonal norms. We have entered the month of November whereby the S&P 500 historically averages a strong advance as volume drops. The November/December climb is one of the most fruitful of the year and is often associated to holiday activity and other year-end efforts. Yet, another seasonal norm that raises serious questions is the expected drop in volatility through this month. We are already at extremely deflated levels as investors grow incredibly sanguine on the increasingly discussed risks. To assume we will just ride out with prices of perfection and a horizon with nary a wave of trouble is simply impractical. To give a sense of just how extreme the expectations are in volatility terms, we can look at the speculative positioning on VIX futures. The securitized product of what was meant as a hedge has attracted aggressive trading these past years. At present, the speculative interests in the future market are holding a record net-short position on the volatility measure. That is despite being substantially deflated. That smacks not just of complacency but of outright hubris. 

Top Event Risk - for Volatility Rather Than Systemic Trend - Through the Week 

When you are looking for the biggest fundamental impact, it is best to find the systemic undercurrents that can strike a nerve for the entire market and thereby develop true trends. However, those measures are not always clearly directed and properly motivated, as is the case seemingly for the week ahead unless something comes out of the blue. That doesn’t mean however, that we cannot expect event-driven volatility for different currencies and regions’ assets. Here are the events that I think can carry the greatest impact and why through each day this week. 

On Monday, there are some interesting events like the UK House of Commons voting on its new speaker, but it is new ECB President Christine Lagarde’s first official speech in her new role that is most interesting to me. There is a clear rift at the central bank which either threatens to curb the aggressive support it has issued these past years or threatens to call into question the effectiveness of their efforts – that latter scenario may happen regardless. On Tuesday, I will be watching two key events: the RBA rate decision and US service sector activity report from the ISM. The Australian Dollar is a carry currency and it depends heavily on its comparatively higher rate of return to draw foreign capital – especially now when the health of China is called into question. If this group offers a mere escalation of the dovish rhetoric – and not even a cut, the Aussie Dollar has some pent up premium that can be cut back. Ultimately, the US services report is one of the most important indicators overall because it represents the vast majority of output in the world’s largest economy. The manufacturing sector in the US has contracted for four months and services has been keeping overall growth afloat; but it has been showing signs of wear. 

On Wednesday, we are due Germany factory activity which is a good proxy for this key economy’s malaise as well as plenty of Fed speak. My top event though is the earnings report from Baidu, the Chinese search company. This is an important business update for the economy (as with the likes of Alibaba and Tencent) which can offer a more reliable gauge of the country’s health than even official and private figures that relate directly. The Eurogroup meeting on Thursday will produce the economic outlook from the European Union which can tell us how one of the largest economies collectives in the world is doing from their own perspective – far more important than a BOE decision and economic forecast which is constantly snowed in by the Brexit uncertainty. On Friday, Chinese trade will be a figure to watch, but I won’t hold my breath for volatility. Instead, the US consumer confidence figure from the University of Michigan can leverage bigger moves in US speculative markets given how aggressively they are priced.