Line in the Sand

As if on cue, the bond market responded to my pleas for a rising rate environment. The weakening data over the last few months, combined with a serious increase in headline risk had, up until now, kept the party going in fixed income land. But now a rising oil price has sparked dormant inflation fears, causing a reversal in U.S. Treasury yields. Strength in the front end of the curve is now pressuring the longer dated issues, with a 'Hawkish Fed' tone to the bearish bond sentiment.

The recent rush to park money in bond funds should be short lived, given the subsiding level of stock market volatility.

My bearish argument is bolstered by the massive size of this year's Treasury calendar. The recent U.S. tax cuts remain unfunded by any concomitant spending restraint or revenue enhancements. The QT program is still on track to remove the 'emergency' purchases by the FED. This is sure to keep the pressure on yields, absent any flight to safety bid from a geopolitical externality.

So what is holding stock buyers back, especially the value oriented buyers of 'cheap' Financials?

It's that level ... 3%.... that has them spooked. An imaginary line in the sand.

What is it about round numbers that causes formerly rational investors to freeze in their tracks? What does it matter if Apple reaches $1Tn in market cap, Bitcoin breaks $10,000 or oil goes to $100/bbl.

What I learned when the Dow first crossed 1,000 in 1982 still applies. Round numbers mean nothing!

I believe this worry about 3% is much ado about nothing. The angst currently being expressed about a relatively meaningless number is completely disproportionate to its actual financial effect.

I call this the "guns at the border" effect. Like when the U.S. built up an army on the border of Kuwait, in preparation of expelling the Iraqi army. The market sold off in advance of the event and rallied on the first shot. Bring on a '3 handle' for bonds. The 'sell the rumour - buy the news' effect is looming large for stocks.

Valuation has comfortably adjusted recently. A sub-16 forward p.e. on rising earnings, with comforting credit conditions is usually a recipe for rising stocks, even at 3% bond yields. First quarter earnings have back-filled previously elevated valuations, making stocks more attractive than bonds. Fears of a cycle-ending recession are premature. The yield curve, and its well-telegraphed march to inversion has another 50 bps to travel before red-lining.

So buy the banks here hand over fist.

Their earnings, capital ratios and business efficiencies are fantastic. The relative valuation has never looked better, given all the problems elsewhere in the market. Credit markets have behaved well despite the hue and cry from nervous commentators. HSBC is a good looking chart here, with a specific catalyst of a new CEO making transformative changes. I'm also buying AMTD, after yesterday's dip. The stock should benefit from higher short rates and increased client activity over the next year.

The market is poised for a rapid rotation away from the momentum leadership groups. The relative performance of 'Momentum' against 'Value' (shown below) is stretched and potentially rolling over. Google reported great numbers but the reaction to them says a lot about the unwinding FANG trade. Apple looks positively horrible, and Facebook is still my (and Gundlach's) favourite short. Tech is consolidating; the profit-taking motivation being provided by the spectre of increased regulation and flat cell phone replacement cycles.

What we need most right now is accelerating economic global growth. The market's response to current earnings is being 'Trumped' by diminished forward looking expectations. The uncertainty caused by the '2018 Trade War of Words' is mostly to blame. But the 'Art of the Deal' style of negotiations from Trump is actually working. We got a taste of that yesterday with Mnuchin's olive branch to Rusal. Trump needs these issues to be resolved before the fall election cycle.

Although the 'second derivative' of Euro-zone growth has peaked, the level of monetary accommodation is still extreme. Draghi is likely to message that on Thursday, soothing recession fears. The path of least resistance is still up for Europe, although perhaps at a slower pace that last year's above-trend growth rate. Oh yes, the weather is getting better too. The German Q1 data was affected by the worst winter in 20 years.

The most recent China data have been strong and Asian economic prospects are being enhanced by the recent geopolitical cooling. Even Japan's economic zombie economy has shown signs of a spurt.

Commodities, other than oil, have pulled back on this week's bounce in the U.S. dollar. Sovereign yield spreads, especially in the front part of the curve, motivated a short covering rally into the greenback. But if this pullback in hard assets is predicated on stronger growth and higher inflation expectations, it's hard to be too bearish.

Oil is accelerating, as the late-coming crowd piles into the seasonal trade. Cheerleading from the Saudis, positing the potential of $100 a barrel, didn't hurt either. Anybody see any linkage with this rhetoric and the upcoming IPO of Saudi Aramco? There is plenty of $60 oil to go around for now in my view. I'm still long my oils for now, but as a wise PM once told me "they go down you buy, they go up you sell". Oh wait a minute, that guy was me!

QSR Downgrade

There was a downgrade of Restaurant Brands International (QSR) by a noted analyst and perennial barn door-closer last week. Funny, I seem to remember recommending a short on that name in January about $10 ago. Funnier still, now that the news of franchisee and labour unrest has reached the front page level, I moved to cover my short.

The strong U.S. burger and chicken businesses are far more important to QSR than the Canadian doughnut market. Like booze and cigarettes, Timmy's sugary, fat-rich product offerings will be a hard habit to break.

Double-double down on the long side.

Oh well, some people just don't get the gist of "expect the expectations of others...".

Risk Model: 4/5 - Risk On

The RSI level of 50 says it all. Neutral. But with a bullish bias. The VIX has subsided nicely. The AAII Bull/Bear ratio bounced off a two year low. Although it's slightly below the buy signal, I'm expecting that to improve given this week's calm market and strong earnings reports. The Copper/Gold ratio has bounced and looks poised to rally now that gold has lost its bid.

The 2 month correction has rebooted the market, so I've given up on my major Q2 top thesis. Its back to stock selection research for me. Dammit, the driving range just opened today too!