Keeping it Real
The recent quick correction - one that satisfied nobody, was almost over before it began. The insatiable bull market has quickly become overbought, and the FOMO buyers are out in full force. The lack of downside follow through to 'test' the bottom has presented investors with little to go on for guidance. We are back to dangerously chasing popular leadership, Technology, Financials and Industrials. A double top pattern is now a distinct possibility. Breadth and volume non-confirmations are setting up potential technical sell signals in all the major leadership sectors.
Where does a refreshed leadership come from?
Although lagging energy stocks have prevented the baton pass to Value from Growth at the macro level, I note the stealth bull run forming in many deep cyclicals. These low price-to-book companies have been on a tear since the early part of last year and the continuation of the run is at hand. Yesterday saw a successful break-out from their short term 'cup and handle' formation, typical of a base pattern. I'm long the group and looking for a good run into spring.
A reliable technical pattern has become evident in a significant number of global cyclical stocks. It represents a welcome avenue of diversification from the crowded and popular large-cap tech stocks. Below, I show the classic 'cup and handle' pattern below in its generic form. This a bullish formation, as it confirms the breakout from a period of base-building.
Cup and Handle Pattern
It looks like a similar form is shaping up for this group.
S&P Metals & Mining ETF
Copper seasonality is at its height in the first five months of the year. This is one of the strongest seasonalities I know of. The metals markets are pushing to new highs, lead by zinc and nickel. Iron ore prices have recently surged to new highs.
The strength in metals ultimately means higher interest rates. The current cyclical inflation backdrop is on the verge of bubbling over and the complacent Fed will be behind the curve shortly. Jay Powell's testimony today is following the McFerrin doctrine of 'Don't worry, be happy', ensuring that an overheated economy will ensue. He won't be whistling that tune if he has to jack rates later this year during an inflation scare.
The interest sensitive sectors have enjoyed a feeble bounce after breathing a sigh of relief that the 10 YR didn't beach the 3% danger zone. The weak Durable Goods order drop over the last two months seems like a head fake. Sell this bounce in treasuries.
I believe have companies paused spending intentions to review the tax reform impacts. I expect the capital spending order flow to accelerate during the next few months, adding inflationary fuel to the fire.
I'm starting to like hard asset stocks, including golds and energy. They respond best during periods of negative real rates. The market may soon perceive the Fed to be asleep at the switch. As inflation expectations accelerate, resultant negative real rates will drive the U.S. dollar index lower boosting commodities.
The eurozone is strengthening and the Italian election worries are overdone ( they've had 61 governments in the last 67 years so what's the big deal?) The Euro bull run is intact as is the break-out in the Japanese Yen. China is back from vacation and the recent move to shore up Anbang is effectively an easing in financial conditions, especially in their fragile credit market.
This negative real rate environment is currently not a concern as rising short rates have exceeded the rising PCE inflation rate. The chart below subtracts the PCE inflation rate from the 3 Month bill rates for a measure of 'real rates'. Anything above the zero line is bad for the inflation trade. But this chart could reverse quickly if rate increases fail to keep pace with rising inflation data. I am watching for a reversal before becoming more aggressive on the hard asset trade.
3 Month Real Rates
Risk Model: 3/5 - Risk On
The Copper/Gold ratio is slightly below the 50 day average as both metals are pausing to absorb the Powell testimony and recent data releases. The VIX is still hovering above the comfort zone of its 50 dma, which stands at 15.
The weekly RSI has bounced back to mid range and the rising 200 dma is supportive.
AAII bullish sentiment held strongly above the moving average after the quick restoration of confidence following the short-lived correction. Notice how the moving average has been steadily rising since December after being flat for two years. The 'bull market in pessimism' has finally been put to rest.
P.S.
I changed the background picture on the website to a photo I took of the Bald Eagle that lives near our temporary Florida island home. The fact that he's looking backward is possibly a political statement but I don't want to read too much into it. It's just a nice photo.