Leadership Failure

What signs does one look for to spot a market top? How do you know you are at an inflection point? When does a trader know to start fading the trend. Analyzing leadership is the key.

Among the leadership stocks of 2018, Amazon Netflix and Microsoft are standouts. They have single handedly accounted for over 70% of the advance of the S&P 500 this year, a fact not lost on most money managers. Active managers are usually value biased - overweight the lagging financials and underweight expensive growth stocks like $AMZN. Not a bonus enhancing strategy. But they are unlikely to panic into the momentum trade in the fourth quarter.

So yesterday's market action following the highly touted USMCA agreement was instructive. A pathetic morning rally failed to advance throughout the day. The close was disappointing given the 'good' news of a trade deal. By day's end, Magna, a company that stood to lose on a failure to get a deal done, was up a statistically insignificant 3%. And how pathetic is $BNS, the most NAFTA sensitive bank? Today it is down again on rate hike fears.

What is wrong with the market that it can't rally big an good news? Is it out of gas?

We come into this morning with news that Amazon has proposed to raise wages, presumably to blunt criticism from those concerned by rising income disparity. Bezos, the world's richest man, has recently had a bullseye pinned on his back from Democrats and Republicans alike due to his high profile and pointed political views. No wonder he preemptively handed his labour force an early Christmas bonus.

But does that mean the Amazon prime subscription rate will similarly rise - generating a spurt to cost-push inflation? No, they already did that earlier this year and a second hike would create huge consumer backlash. Inflation surges cannot come from increased costs in the hyper-competitive retail world of today. Amazon will have to eat the increase as it tries hard to attract much-needed workers. Cue the negative estimate revision. The stock could be losing leadership.

And on top of rising labour costs we can add a major increase in energy costs, courtesy Trump's Iran policy. In advance of the increased sanctions on trade with Iran, Oil buyers are trying to rebuild stocks in front of the seasonal demand increase from colder weather. This temporary demand has pushed futures prices and emboldened the permanently bullish "spec trader" pack of hounds.

Longer term, I'm not a believer in the $100 oil world. As I have stated previously, there is lots of $70 oil to go around in the medium term, let alone $85 Brent. As day follows night, it won't be too long before a supply response quashes the current run in oil. The compelling economics of Alberta's stranded crude is a perfect example. Cenovus just signed a major deal to ship oil by rail to the Gulf coast. Even after a C$23 shipping cost they are making money.

An don't for a minute think that China, who already accounts for 25% of Iran exports, won't take all the Iranian crude it can handle. In the escalating trade war with the U.S., this would be a perfect counter-measure for them to employ.

For now, rising oil prices are another earnings headwind. But investors aren't biting. I think the oil stocks are saying the same thing as they fail to confirm the new price highs. (see below)

Oil Stocks Relative to Oil Prices

So Amazon will be the litmus test for the bulls as we head deeper into the uncertainty of the Mid-Term elections, Brexit and China trade issues. If the leadership stock takes a break, the market may follow. Watch the Tuesday at 11 effect today carefully for any clues. - it needs to put on a show today to save the market.

Inter-market action yesterday was also mixed for the bulls. Copper was down. Treasuries are steady, enjoying a risk-off bid from the flight to safety crowd that are reacting negatively to the slow motion blow-up in Italy. The governing Northern League party, pushing to get their 2.4% deficit budget approved, have upped the ante with a go-it-alone currency comment.

Rotation to value stocks is just not happening without a correction. The banks are acting poorly, never a healthy sign. For them, the ever-flattening yield curve is rock that is getting increasingly hard for them to push up the hill. Commodity stocks are similarly moribund.

Fresh leadership, sorely needed, seems perversely far away after yesterday's Pyrrhic victory by the Trump trade team. As they turn their sights on China, more economic bad news awaits companies like Walmart, Boeing and Caterpillar, some of the major leadership stocks of 2018.

Lead, follow or get out of the way someone once said.

I'm still out of the way of this bull market.

Risk Model: 3/5 - Risk On

Although still in risk on territory, the model is now highly vulnerable to a risk-off shock. Should anything upset the apple cart, the 3 month Vix and copper gold ratio would reverse negatively creating an instant risk-off signal.

Rather than stay with the model, as I have most of the past three months I am sitting on the sidelines awaiting a corrective phase. The key element

of sentiment - AAII Bull/Bear is still negative, reflecting a cautious investor base. The low volumes are getting scary.

The large equity inflows of September, somewhat related to the reconstruction of the GICS index groups, are now behind us. The low volatility we have experienced seems like a beach ball held under water, just waiting to react. I'm on black swan watch now.