Yield Signs

Last week, an abrupt spike in global yields ushered in a leadership change in the market. German Bunds, the linchpin of the fixed income market, rose 20 basis points in a matter of hours after the ECB posited a tapering of stimulus. But the clearest clarion call for the cyclical rotation came from a violent sell-off in the winning first half trade - Growth.

Now that the quarter-end inflection point has come and gone, (all the windows were dressed), it's time to change gears and buy the cyclical summer rally.

The Tech sell-off was a long time in coming, but it was welcome relief to many sidelined active managers. The leadership change last week was clear and decisive. The double bottom in the U.S. Treasury 2-10 yr yield spread, if it holds, will actually serve to prolong the market cycle. Rising inflation expectations reflecting improved global growth are necessary to forestall a curve inversion thus allowing for a successful rotation from Growth to Value.

Risk-on behaviour was also confirmed by the break-out of the copper/gold ratio from its 6 month flag pattern as the safe haven metal (gold) has ceded control of the markets to Dr. Copper.

The much-discussed dichotomy of falling yields and rising stock prices is a stale-dated concept now. How could the market keep rising if yields were dropping, the bears asked. Aren't the Bondies always right?

There was no dichotomy, really, as the market leadership, Tech and low vol, was simply inflated by the lower discount rate implied in the bond market. The bond market was, in turn, being driven by weakening U.S. data and QE from abroad.

Both those factors are spent forces. Signals from improved global growth in both the Eurozone and China are taking focus away from tepid U.S. data and the Trump-slump. The mini taper-tantrum in the Bund market following the ECB's verbal trial balloon predicts a 2018 tightening bias.

Yields are set to rise now, clearing the way for a catch-up trade in the Financial and Resource stocks that have recently plumbed multi-year relative strength lows.

The low-vol trade was anything but last week. The popular $SPLV, Powershare's active min-vol fund, was down hard last week and underperformed the broader average.

That's not supposed to happen to a product that defines itself as "smart" beta. It shows just how crowded the safety trade is. Not so smart.

We will need to see a confirmation from economic data to gauge the duration and magnitude of this rotation. Commodities always run up in advance of the data, however, jumping the gun more often than not. Oil is especially tricky given the high elasticity of the supply curve. Getting to $60 and staying there is a tall order as cost profiles of all but the most expensive oil sources have dropped below $50. Copper smartly responded to a stronger than expected China PMI and, importantly was confirmed by the remainder of the base metal complex - zinc +1.8%, lead +2.7%, nickel +3.5%.

Sentiment is Turning

Below is the Merrill Lynch sell-side sentiment gauge, (useful in a contrarian way), indicating a break in the bull market in pessimism that has dominated markets since the 2002 top.

Similarly the AAII Sentiment survey is poised for a break out from a multi-month rounding base. The bears have been dominant for too long.

Only a better set of macro data can create the break-out from this funk as the prolonged pessimism has mirrored the weak global cyclical environment. As well, the surge in Tech/Low Vol has driven valuation into the upper range, engendering a bearish tilt to investor perception.

Should the cyclical components take hold of leadership, the influx of cash, now parked on the sidelines because of those valuation fears, would be enough to prolong the bull. I'm hoping.

But this time hope may actually be the right strategy!

Risk Model; 3 out of 5 - Risk On

Only the lack of upward momentum (RSI 44) and a cautionary AAII sentiment rating are negative readings this week. The VIX has stayed low despite the sell-off in Tech probably due to the rotational counter move in Financials and Energy. Copper/Gold has moved into bull mode as discussed above.

I'm hoping for a risk-on signal from the AAII this week but the survey is released on Thursdays.

Happy trading!