BCA Research observes a similar Broadening of Global Equity Rally, ``Our breadth measure for 36 major country markets has rebounded sharply in recent weeks, indicating that there is increasing participation in the equity rally. This reflects growing optimism that the U.S. economy will enjoy a soft landing and that inflationary pressures will diminish, (emphasis mine) judgments we concur with. Still, although breadth is improving, more growth-sensitive markets, industries and stocks are lagging as global economic growth moderates.” The same spin we heard last week...soft landing and lower inflation.
Figure 5 Economagic: CRB Futures vs. CRB Spot
As I’ve always noted: perspective is a matter of choice or from the lens one chooses to use. As authorities from the US Federal Reserve continue to argue of “risks of inflation” (as per St. Louis Fed William Poole and Chicago Fed Michael Moskow) the market adamantly sees it otherwise.
The apparent dissonance can likewise be seen in the patently contrasting behavior of the commodities market. Yes, we have noted of falling commodity prices lately, which has been used by the Panglossians on the premise of “lower inflation” for continued cheerleading, however this viewpoint emanates from the FUTURES market, whereas in the SPOT market, the CRB commodity index has climbed to new highs (Figure 5) for a radical departure!
According to Ivan D. Martchev editor for Global Viewpoints, ``But this looks to be the largest divergence between the two since this particular spot index was introduced. They’ve tended to move in the same direction. This makes no sense if you believe the “inflation is coming down--fast” scenario. Perhaps margin calls on futures positions have created an illusion of lack of inflation.” As an aside, whereas some commodities have been down, others have been breaking new records such as Lead, Wheat (10-year high!), Corn (strongest week in 18 years!), Nickel (19-year high!) and Orange Juice (16-year high!). As a reminder, inflation manifestations do not come equally. They get to be revealed in different channels.
As I’ve previously said, today’s markets have been all about inflation (too much money and credit chasing too few investments) with apparent disregard to valuations. Markets believe what they want to believe, they have marked inflation as simply oil, or gold and some other commodities instead of its monetary origination. They hanker for “low” inflation to justify “more inflation” (through higher asset prices).
Revered fund manager John Hussman calls it the “Scarcity mentality”, where people ``magnify trivial differences when the stakes themselves are trivial.” Relative to the investing world, where returns have been trivial (diminishing returns) as the flood of money and credit have been used to bid up even illiquid assets around the world, where over 8,000 hedge funds with over $1.2 trillion dollars in managed funds have employed basically the same investment strategies (herding), all for the sake of generating higher returns or the Fund manager’s “Alpha”, more leverage or credit provision is needed. And this required “leverage” could only function under a loose or highly liquid monetary setting or the so-called “low inflation” environment sought after by such market participants. Needless to say, more leverage translates to higher degree of risks (tail/sigma risks-low probability high impact).
Mr. Raghuram G. Rajan, Economic Counselor and Director of Research of the International Monetary Fund identifies the breadth of such risks in his recent speech (emphasis mine), ``Indeed, I do think the greater concern has to be about the rest of the financial system, the 80 percent of value added by the financial sector that is outside the banking system. The non-bank sector is increasingly central to economic activity and is not just a passive holder of assets. Moreover, some non-banks such as insurance companies and some hedge funds are subject to runs.” So essentially non banks have been important sources of liquidity generation as previously argued.
Figure6 Moneyandmarkets.com: Crowded Trade
When we tackle upon risks we equally note of the ongoing market sentiments influenced by the highly leveraged system. Figure6 shows you that the market consensus or has bet heavily into the soft landing-low inflation scenario. According to Mike Larson of Moneyandmarkets.com (emphasize mine), ``It shows trading activity in 10-year Treasury note futures among large speculators. These are the hot money players using leveraged bets to try to make big profits from relatively small bond market moves. In the week ended October 3, a lot more money was betting that 10-year bond prices would rise. These speculators were holding 520,871 contracts more than the people betting against bond prices. Not only was this difference up 9.5% from a week earlier, it was also the single highest level in recorded history — almost twice the previous record from last March.”
Two important observations here: one, big profits from small moves by leverage bets, which again underpin our inflation-leverage standpoint (discussed above) and second, speculators have taken in a one-way or crowded bet; when everyone piles on the same theme, a large probability of a reversal becomes imminent especially when these bets have been anchored upon leverage. 
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