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Surprise, Surprise, Surprise!


Gomer Pyle (again, sub-50 crowd, I apologize - YouTube him) would have been an excellent economist. He had the right mix of naiveté of and wonder at the surprising developments in his daily struggles through life. Although he was relatively unprepared to face the newly presented facts, he was always willing to incorporate them in his thinking.

Economic Darwinism at its best is always staying adaptable. But staying objective in this market has been difficult. The Growth PermaBulls have had the upper hand, with the strong economic and earnings performance this year. The equity momentum play is a tough competitor for value based investors after so many false starts to the sorely needed Growth/Value rotation.

And adding to the woes of the long-forgotten cyclical players, is the recent rollover in the Copper/Gold ratio. The decline for the "Dr. Copper" indicator is all the motivation necessary to capitulate on the few remaining economically sensitive bets.

Its no wonder commodities are falling, given the Trump administration's twin threats of "King Dollar" and "MAGA" style trade policy-making.

Copper/Gold Ratio

Adding fuel to the fire is the now coordinated deceleration in the forward looking data. Citi Group Economic Surprise indicators for Europe, EM and the U.S. are now all below the zero line. All three indicators are negative!

I expect the expectations of others (thanks again, JMK) won't be so rosy as they have been lately. Surprise, surprise, surprise indeed.

CitiGroup Economic Surprise Indicies

Although the narrowing market has made new highs based primarily on the earnings surge from the tech sector, a broader participation will be required to generate further upside. Banks are acting poorly. Auto and Housing indicators have peaked. At some point, its the economy stupid!

You would think from looking at the NASDAQ that nothing was wrong, especially given the compressed level of volatility in recent months. That indicator has stayed subdued, lending support to the summer rally players.

3Month Stock Volatility

But the 'summer of our lack of discontent' is now over. Back to work vacationers, there is trouble brewing.

Market technicals are scary. Volume confirmation of the new highs has been pathetic. Breadth is similarly lower than the prior peak level.

Now the worst seasonality period for volatility looms ahead. Today the indicator has risen above the Model's sell signal 100 day moving average.

What part of 'sell' don't you understand?

Seasonality of S&P Volatility

The pre-election period is likely to produce a fractious narrative that will test the resolve of the complacent risk-on crowd.

Throw in the potential for Chinese retaliation on tariffs and a few Mueller/Cohen headlines and you get the makings of a spike in the "fear gauge".

Already GOP infighting on the Canada trade issue has begun to distract Trump from this golf game. He pulled his name off the tee sheet yesterday. Just like Volatility, I think his handicap is going to go up.

Got Vol yet?

Risk Model: 3/5 - Risk On

Although the model has kept the faith that I lost long ago, I see a crack starting to form in the above noted complacency. The AAII Bull/Bear ratio has become very volatile this year in the face of the tweet-storm world in which we now exist. The $VXV volatility indicator has spent most of the year below the buy signal 100 Day MA, offsetting the sentiment indicator over the past three months. That 'cushion' for the market is likely to evaporate, should today's $VXV rally hold. The Bull/Bear ratio forays into positive territory this year have not lasted long.

Risk appetite levels are unlikely to rise over the next few weeks given the headline risks. This portends a 'risk-off' shift in the model, potentially confirmed by a bearish signal upon the release of new AAII survey results on Thursday morning.

Remember, the 'Model' is a guideline for risk appetite, not a strict rule!


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