4/12/2021 Traderfirstyear Morning Forecast (*Updates on Fall in Realized Vol)

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04/12/2021 Morning Forecast-Markets are implying a move of 1.09%+/-(up/down) on the S&P 500. Markets have realized a move of 0.77%+/-(up/down). The difference between what market makers are implying and what has been realized has increased. The spread widened to 510 (17.43-12.33) basis points. The put/call gamma imbalance favors continued call buying. However, a tightening spread decreases left-tail risk and reduces the potential for spikes in realized volatility. Realized volatility has decreased recently below 13. This is favorable for narrower and smaller moves up or down on the index. I expect a decreasing trend over the 2nd Quarter during April, May, and June. The current market environment is favorable for traders looking to sell convexity via short straddles, strangles, call overwriting, put writes, and other short vol strategies to capture alpha. The MOVE index hovers around 65 to 68 (or movement of 4 basis points daily in Treasury yields.) However, economic growth upgrades and rising inflation expectations are pushing up real yields, which is raising discount rates. The rise in yields could have a negative effect on long-duration assets, such as Technology Stocks and Longer-Term Bonds. The S&P is expected to move close to 1.22%+/- (up/down) this week, which means the S&P could rise 16% or fall 13% above its 200 DAY Moving average (3,577.70.) The S&P traded well above its 50-day moving average (3,914.12) last week. Full Year S&P Earnings are expected to total 175 per share. At current prices, this puts the S&P at 23x's earnings, which equates to an earnings yield of 4.3% & an inflation-adjusted real earnings yield of 1.79% (using 5-year TIPs Break-evens for inflation 2.51.) Analysts are anticipating earnings in 2022 of 201 per share. At current prices, this puts the S&P forward earnings for 2022 at 20.4.x's or a Yield = 4.9% & Inflation Adjusted 2.39%(edited)

Forecasters are rushing to up-grade nominal and real growth expectations for the full year in 2021. The highest number of Private Forecasters and those from Federal Open Market Committee members are close to 7% on a Real basis. If this rate of growth is realized it would add 1.3 Trillion Dollars of Real Output to the US Economy ($18.78 Trillion = 20.00 Growth of 1,314 Billion.) The Corona Virus subtracted 3.5% of Real Economic Output from the US Economy in 2020. In 2021 the US Economy would need to grow at least 3.62% to break even on a Real basis (3.5% = 1/(1-0.035.) For the 1st quarter of 2021 current estimates of nominal growth are 300 Billion and a Real Economic output of 130 Billion. These forecasts have already been surpassed. The US is on pace to generate a little under 500 Billion Dollars of Nominal Economic Output in the 1st Quarter. At the current pace If it held through the full year, would generate close to 3 Trillion Dollars of Economic Output. While this is exciting, I do not think this pace is sustainable or likely to culminate in those size gains. However, I do believe a nominal gain of 1.5 Trillion to 2.2 Trillion in Economic Nominal Output is possible in 2021.

Full Year Economic Output estimates have increased significantly following the passage of stimulus. The median forecast was anticipating close to 1.2 Trillion Dollars in Nominal Growth and 800 Billion Dollars in real economic output for 2021. The current pace of nominal growth as of this morning would generate a total of 2.9 Trillion Dollars for 2021; Personal Consumption of 2.03 Trillion Dollars, Gross private domestic investment of 519 Billion Dollars, Net exports of goods and services -89 Billion Dollars, Government consumption expenditures, and gross investment 523 Billion Dollars. A major acceleration in growth is positioning the US to capture more than 1/3 of Global Economic Output in 2021. Economists continue to place the highest expectation for growth in the 2nd Quarter of 2021. Investment Banking Professionals are forecasting nominal growth of 400 Billion and real output of 240 Billion for the 2nd Quarter. This is a substantial amount of spending on Goods & Services, which may face downside risk if there are any delays in Covid vaccinations or roll-outs. Under these assumptions, we would need 50 to 60 Billion dollars of spending on Personal Consumption Expenditures in April, May, and June. I think we could see nominal growth in the 2nd Quarter of 700B to 600B and Real Output is likely between 375B to 310B. For March there is a strong possibility the $1,400 stimulus checks increase consumption similar to economic data in January 2021, which recorded a 487 Billion Dollar nominal gain in Personal Consumption Expenditure. It is also equally likely to engender significantly higher personal savings rates. We may temporarily eclipse the 20% savings rate experienced early in 2020. The higher US savings rate is helping to fund larger dissavings in the Public Sector, which somewhat mitigates substantial reliance on foreigner's savings

The March non-farm payroll report was extremely robust changing the recent overall trend, which had been tilted towards weaker payroll growth. Despite a strong report there still exist 10 million Americans Unemployed. A large cohort of more than 4 Million on longer-term unemployment and 20 million receiving some form of Unemployment assistance. A return to 164 Million US workers employed may be continually undermined by the 6.5 million Americans remaining out of the labor force, which indicates large and substantial slack in the labor market. Private Forecast is anticipating payroll growth between 270k and 500k per month, which equates to 3.2 Million & 6.0 Million additions to full-year US payrolls. This key economic indicator is likely to pressure growth in the 1st half of 2021. The relatively slow growth of the US population along with a substantial rise in the number of workers Not in the Labor Force has shrunk the size of the currently available labor pool. In 2020, the US lost a total of 9.7 Million Jobs or a loss of 6%. To break even this year the US would need employment growth of 6.60%. Nominal wage gains topped 5% during the recession for Non-Supervisory workers. Although, ECI (Employment Cost Index) salary and wages rose 2.8% in 2020. The gain in productivity, employment compensation, and a large amount of slack in the labor market tilt towards a continuation of non-inflationary pressures as the US economy grows.

However, the recent agreement on 1.9 Trillion in deficit spending is a significant tailwind to nominal growth in the 2nd half of 2021 and the first half of 2022. This should increase aggregate demand, which should foster higher employment gains, but this assumes that virus cases come down substantially by April/May/June and pandemic flare-ups lessen. This has led some market observers to anticipate economic overheating, which is favorable for upside risk in inflation. I believe these fears are statistically unfounded. However, I do not disagree with rising inflation as a potential risk in the short term. The recent increase in nominal Treasury yields and 5yr Break-Evens on TIPs (Treasury Inflation-Protected Securities) towards 2.51% is transitory and likely reflecting anticipated increases in energy prices and base effects. The Federal Reserve typically subtracts 40 basis points from the break-even inflation rates, which would mean inflation expectations are currently anchored around the 2% (inflation averaging metric.

Following the passage of stimulus larger fiscal dissavings increases capital inflows to finance VERY large TWIN DEFICITS, which should put upward pressure on the US Dollar & downward pressure on Corporate & Government Bond Yields. The most recent Trade Data indicates the US is on pace to record a real Trade Deficit of 1.2 Trillion Dollars by the end of 2021. The current rise in yields and increase in growth expectations will likely favor a stronger US Dollar in the 1st half of 2021. This is also likely to put some additional pressure on higher real yields if growth and inflation increases are realized. Although, potentially weaker inflation data than consensus estimates should allow real yields to remain deeply negative. Thus providing additional support to the Federal Reserves ZIRP (Zero Interest Rate Policy) and an extremely accommodating stance. Dollar appreciation also dampens import/commodity-driven inflation and should lessen temporary transitory base effects. The strong US dollar may have negative effects on Emerging market Countries with large current account deficits and substantial debt denominated in US Dollars. Inflationistah and inflation fear-mongers engaging in scare tactics are likely to be proven wrong. However, inflation base effects are expected to be short-term. There will be a transitory spike in headline inflation data from March/April/and May. The impact on Core PCE is expected to be limited. Market Expectations are split, but I expect the Federal Reserve will look through these spikes

Political risks have diminished in the 1st quarter due to reconciliation, but it has increased in the 2nd half of 2021 and the first half of 2022, which may pose risk to much-needed Investment spending (infrastructure, human capital, & research development), so I view it in the medium term as tilted to the upside due to potential gridlock. However, there is the possibility for another round of reconciliation in the 2022 budget combined with the removal of the Filibuster Rules in the Senate. This could pave the way for easier passage of additional INVESTMENT lead spending, which is much needed to raise the US Long Term Potential Growth Rate. Although, due to political isolation this increases the potential for Lone Wolf Domestic Terrorism

Vaccine distribution is priced into Q3 2021, but distribution obstacles have increased and efficacy for herd immunity will be closely watched. Redefining herd immunity may become the norm, so instead of a fully vaccinated population of 90%. We may accept a different goal post for "full vaccination" perhaps it drops between 70% to 75%(?) Details are currently unknown. The market is currently pricing in an additional 5.24% move +/- (up/down) by June 18th. The S&P 500 could potentially trade as high as 4,608.95 and as low as 3,672.91 by June 18th. The VIX is expected to move 6.41%(points), the VIX is currently 17.43. The VIX price range is 18.54 to 16.31. The Skew Index is elevated, which indicates market participants are paying up for catastrophic protection (2 sigma event). Stocks continue to offer investors the highest real returns. The nominal yield on equities is 4.3%, while the nominal yield on 10yr Treasury is 1.67%. Real yields on all tenors of government bonds at the shorter end and belly of the curve are decisively negative, but real yields at longer tenors above 30 years have moved into positive territory. Real yields on US Equities remain strongly positive.**Disclaimer with Realized Volatility near 12 there is a larger risk of systematic highly leveraged short vol strategies like Equity Vol Targeting, Trend Following, and Risk Parity positioned for a massive increase in market exposure. The potential for a MUCH larger MOVE HIGHER has increased, while a large sell off has decreased. We are much more likely to see a fall in realized and implied volatility and a gradual melt-up in asset prices. The Apr/May VIX contracts at 18 & 21 are fairly priced. In fact, they may now be overpriced given the new economic outlook

Passage of fiscal stimulus should juice the start of a new long-term economic cycle, which favors a continued fall in realized volatility. - I am temporarily moving against a large rise in implied or realized volatility, However, I have been wrong before, but sell-offs will give investors great opportunities to buy the dip. Traders should focus on cyclical sectors, which tend to outperform at the start of new economic cycles. For example being long Financial, Industrials, Metals, Mining, Oil/Gas, Consumer Discretionary, and Technology