Bottom Fish

The stock market is looking better on this morning's surprising revelation from senior Chinese officials that trade dealmaking is still on the front burner. This has diffusing fears the arrest of Huawei's CFO, Meng Wanzhou would derail the talks.

Meanwhile the Brexit saga bumbles along, with UK PM Theresa May's 'can kick' during yesterday's fractious parliamentary session. Italy, in its ongoing war with the EU, is similarly making nice, proposing to stay with the single currency, no matter what. And the collapsed oil market has bounced on the new production sharing agreement from OPEC, aided by a complicit Russia.

The removal of these threats is important to investor psychology, but it hardly puts in place a trustworthy bottom. They are important building blocks, but hardly represent a panacea for the global economic outlook.

With a tweet, an executive order, or a resignation, the narrative could change on a dime. As evidence this morning, Indian investors awoke to the news that their central banker has resigned. His untenable position as the sole arbiter of monetary policy has been consistently undermined by a Prime Minister intent on promoting easy money as re-election platform. This is yet another example of a populist politician trampling investor confidence.

So a short-covering bounce is in sight, as investors shift their focus to the upcoming FED meeting. A dovish hike may have already been 'priced in', based on the market's strongly dovish reaction to Chairman Powell's recent speech. Correspondingly, analysts' expectations for future rate hikes have receded, along with their corresponding forecasts of 2019 growth and earnings.

The bottom fish mentality may be valid for now but only the trading fraternity should be happy. Until the core issues confronting the outlook for global growth decisively turn for the better, there is only a sideways choppy trading range to look forward to, in my humble opinion.

A durable 'all clear' would come from a robust re-acceleration of economic growth that doesn't require the input of administered policy easing. Tax cuts, infrastructure spending, and low rates are band-aid solutions that markets have now dismissed as temporary and unsustainable. The contraction of global stock PE multiples that started earlier this year has now arrived on U.S. shores. The false confidence engendered by Trump's MAGA hype has now been replaced by good old fashion fear. The market gut check that emerged in October has dramatically chilled investor confidence.

I will get more bullish on markets when the Treasury curve bearishly steepens, the copper/gold ratio starts to rise and the soul-sucking overreach of politicians subsides. Good luck with that last one Deck.

Meantime, markets are oversold, unloved and cheap, compared to two months ago. I closed out my last short yesterday, looking for a pre-FED, pre Christmas bounce. Due to the severity of the correction, most of the tax-loss and portfolio embarrassment selling has already occurred. The over-hyped '3s - 5s curve inversion' panic is subsiding. Remember, some of the best returns in markets have occurred in an environment of a flat curve.

Some avid readers (thanks Mory, Tina & Stu!) have likened this to the late 1994 flattening. The market took a full six years before it peaked in that flat curve world. Asset returns were robust then, as the "Great Moderation" Greenspan FED era unfolded. With their verbal backtracking in last week's communication, I believe Powell and company may be going back to that same playbook. The "FED put" policy that served markets so well in that era is possibly making an encore.

U.S. Treasury Curve: 1990 - 2001

Current consensus has been for markets to continue to perform well in the first half on 2019, only to succumb to FED tightening and decline in the second half, reflecting a 2020 recession. But like the early nineties, the decoupling of global growth allows for an engineered soft landing, should the FED put be exercised at the next meeting. Then a real rally can occur.

We could use more 'weak' data like last Friday's employment report. That would give the FED cover to change their tune. Again, I think bad news is now good news and we got some last week.

But at least for now, Santa is here already!

Risk Model: 2/5 - Risk Off

The word volatility get thrown around quite loosely in the corrective phase of any market sell-off. Blame is sometimes centered on market mechanisms like program trading or HFT rather than the root cause. Hence the recent decrying of 'algo trading' as the source of all evil. I beg to differ. As long as there have been humans making markets, liquidity has always abruptly contracted during a down phase. Blaming the computers for the sharpness of moves, while convenient, is sloppy and self-serving. Commentators have forgotten that the asymmetry of fear and greed is embedded into the core of any risk market. If the computer is to blame, please explain to me the similarity of today's stock charts to those of the pre-computer era. Adjusting to the seemingly out-sized 500 point Dow swings lately is easy for me. I managed money in 1987 when a 500 point down-move really meant something.

The model is waiting for volatility to flash a buy signal. One clue as to the validity of this latest current sell-off is to look at VVIX Index. This index prices in the volatility of volatility (market nerd heaven!!) by using the option prices on the volatility index itself. The low reading recently implies a substantially reduced level of angst about future expected market disruptions. Markets are actually calming down, despite what the talking heads, and perma-bears have been saying.

VVIX Index