It was roughly 20 years ago that I had an important and memorable conversation with my father. I was deciding what I wanted to do with my life and we were discussing the stock market, economics, and trading. During this conversation he imparted two pieces of wisdom that remain with me to this day:

  1. If you can figure out whether the market you are trading is in a trending environment or an oscillating environment, you will know how to trade it. The trick is that markets are constantly flipping between trending periods and oscillating periods on various time frames. There is no perfect technical indicator(s) to figure this out. The trending vs. oscillating question is the 'holy grail' of trading markets. 
  2. Central banks always want to create a steady level of inflation, however, the bursting of bubbles leads to deflationary episodes. If you can figure out whether you are in an inflationary environment or deflationary environment you will also better know what to do. The tricky part is that these macroeconomic environments can transition very quickly.

My father visiting the Soviet Union in 1970 (a memorable photo especially considering the year it was taken and Lenin's gaze)

So I sit here today on March 15th, 2023 looking at headlines from just a few days ago telling me that inflation is too high and central banks must raise rates another 50bps at their next policy meetings (ECB and Fed). Yet, this morning everything I see indicates that the US economy is in contraction, inflation is falling fast, and asset prices are tumbling.

The US 2-year note yield has plunged more than 120 basis points in less than one week!

If I had to guess I would say that we are in one of those important periods of transition; from elevated inflation to deflation. Similar to what the world experienced in 2008, when the year began with CPI registering around 4%-5%, and ended in outright deflation with asset prices crashing across the globe.

What happens next is not set in stone. In fact, it largely depends upon the response from global central banks. Do they reopen the liquidity spigots to stem the fires engulfing the banking system? OR do they allow the system to burn down and deflation to take hold?

The answer is likely to be nuanced, and unlikely to be received quickly. After all, it was just last week that FOMC members were commenting on whether a 50bps hike was a possibility at next week's meeting.

The risk I see today is that central bankers allow the crisis to burn hotter in order to punish those who took too much risk, and to be sure that inflation is crushed. This morning, gold has risen above $1930/oz after a much cooler than expected US PPI report, however, I would advise against chasing the yellow metal after a more than $100/oz rally in less than a week.

To be clear, that doesn't mean we are no longer in the sweet spot for gold. It simply means that I see risk/reward as being more balanced over the near term after a large price appreciation in recent days. 

If there was ever a time when it is appropriate to apply two of my favorite Fundamental Truths of Trading "Every Moment In The Market Is Unique" and "Anything Can Happen", that time is now. 

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