Rope-A-Dope

The wait is over. Last week saw the end of the long awaited drama. The pundits were beside themselves for weeks as they tried to handicap the outcome. There were countless articles written and opinions were all over the map. The anticipation was unbearable.

And just like that it was over.

Nylander signed his contract.

Oh, wait, I guess that wasn't all that happened last week. There was a FED speech and a G20 dinner party that seemed also to generate some minor degree of interest too. I almost forgot, in all the hype over the second coming of Matts Sundin.

With FED Chair Powell being anointed as a born-again dove following Wednesday's speech, the market rode into the weekend G20 meetings on a high. The S&P 500 gained 100 points in advance of the widely anticipated Xi-Trump dinner meeting. It had correctly bet that the tariff 'can' would get kicked down the road, and it was. And well down the road at that. Unlike Brexit, there was lots of wiggle room in the purposely opaque 'deal'. The complicated process to arrive at a lasting and substantive agreement should take us well past Trump's time in office. Nobody believes that 90 days is enough, but who cares when Tariff-ageddon is seemingly off the table?

And that is the beauty of President Xi's approach. He knows that China had much more to lose in provoking an all out trade war, given the lopsided nature of the current trade balance. And he can ill-afford to embolden his domestic critics at a time of decelerating economic growth and forced deleveraging.

But I didn't expect the Kumbaya outcome from Saturday's meeting. In hindsight, it's clear that Xi has started a game of trade policy rope-a-dope. He knows he has time on his side. Remember, in 1974 Muhammed Ali waited til the 8th round for Foreman to wear himself out before knocking him out. XI's 'agreement' on Saturday was a clear sign that he, like Jerome Powell, blinked.

But we know this highly touted deal-making will take time. Like I have been saying, how can the biggest trade deal in the last 30 years can get negotiated in three months, when NAFTA took two years. And that deal didn't have intellectual property and forced technology transfer issues on the table.

The market today is coming to its senses by selling off. There is no quick fix to the U.S. - China new economic cold war. And stocks still have to come to grips with the sharply diminished earnings growth path in the next six to nine months. And earnings are now being squeezed from a 3.5% increase in worker compensation rates, as the lagged effects of the tightening labour market take hold. Corporate American estimate revision is dropping like Foreman did after Ali's left hook.

S&P 500 Estimate Revisions

The correction may now be over for stocks, but that doesn't mean there is a strong case for an immediate rally, Santa Claus notwithstanding. The next issue of worry is possibly the upcoming employment data release, scheduled for Friday. What does the market do if the number is "hot"? Will FED tightening expectations will be jacked higher, whipsawing the markets badly.

According to CNBC's Steve Leisman, the stock market has had a 20% drop 13 times during the post WW2 era and there have been 7 recessions. So I don't think the October-November swoon is anything but a valuation reset. Having seen a 20+ PE earlier this year, the market had just gotten over it skis and was inconsistent with the core 2% longer term growth rate of the U.S. economy.

Bonds are now adding to the wall of worry.

Today the talk is of the effect of the Treasury curve 'kink' inversion between 3 Year and 5Year bonds. Recession calls have started to surface. Are bonds - as many claim - "smarter" than stocks?

More likely, we are back to a situation that has plagued forecasters since the advent of Quantitative Easing was introduced during the Bernanke era. The intervention in the World's capital markets by central bankers has distorted the major bond market curves. The short run behaviour of the bond markets is therefore now as unreliable as that of the stock market in its predictive efficacy.

As well, the bond market was ripe for a rally. Prompted by the previously hawkish comments emanating from Chair Powell, prior to last week's 'dove-in' speech, traders had built up a crowded negative spec. position in Treasuries. (below) That unwind, like the the one just seen in the crude markets has forced yields in the long end down. The disinflationary implications of lower crude added fuel to the short covering rally.

10Y YIELDS vs SPEC POSITIONS (RHS inverted)

So the squeeze play between the artificially depressed longer end and the front end is playing out in the belly - hence the 3's to 5's inversion. I don't take this as the beginning of the end for the capital market cycle, as the technical nature of the inversion argues that the situation is temporary and is not predictively genuine.

More likely, we will see a see-saw trading range develop over the next couple of quarters. Lingering uncertainty over the major negative drivers of the market, growth deceleration and margin squeezes, will play out in a meandering path of temporary failed rallies. Oil is undergoing one currently, as the prospect of OPEC production cuts has stopped the bleeding. But that is temporary, in my view.

Estimates for 2019 have started to come down. I don't think we have seen the end of them. That is now the driver of stock performance on which we should be focussed. Upside in the markets from multiple expansion is over. Upside from earnings is under review. So the FED and China trade issues have been shelved for now. However, the simmering nature of those two issues is still a tangible risk to markets.

So the bulls have had a reprieve. But like the Leafs, I don't think one signing will be enough

to make everything instantly solved. I'm not setting up my lawn chair on the parade route for the market either.

RISK MODEL: 2/5 - Risk Off

No change here as the decline in volatility has yet to subside enough to signal the all clear (below). As well, the recovery in sentiment last week was insufficient to generate a buy signal. It may come this week but we need to wait til the Thursday release of AAII data. Copper is also failing to signal the all-clear yet, as the China _ U.S. 'deal' has questionable validity from an economic standpoint.

3 Month Volatility vs 100 DMA