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True Confessions

Citigroup kicked off the U.S. earnings season yesterday with a surprisingly upbeat message. In his conference call, CEO Michael Corbat decried the hysteria accompanying widespread recession fears ( read: Rosenburg and Gundlach) by pronouncing the state of the U.S. economy as 'healthy'. This helped the banking sector stage a countertrend rally, muting the Apple-related tech sell-off that greeted traders at the opening of trading.

The bounce in Citi was quickly translated into an 'all-clear' signal from many in the bull camp. "The bear market market is over!" cried Cramer.

I'm not so sure.

I guess this was a normal reaction for a stock that had just dropped 30%+ in just 4 trading days into the Xmas eve liquidity vacuum. Trading at less than tangible book, yielding 3.5% and supported an 8% company buyback pledge, the light volume bounce was to be expected. The optimism expressed by Corbat, however, may turn out to be misplaced.

Guidance for the year ahead is the more critical element for the stock market. I don't hold out much hope that suddenly the earnings outlook is improving just because of a dead-cat market bounce.

In JP Morgan's release this morning, CEO Jamie Dimon pointed to the threat of a protracted government shutdown as a key risk to his forecast. The Q4 miss just announced was based on weakness in the trading account and can be dismissed as backward looking. But the funding impasse in Washington is a more problematic obstacle for the bulls. Add that to the sharp deceleration of economies coming from the well-advanced global slowdown, and it doesn't make for confidence inspiring news flow.

The art of the game for any market-savvy CEO now that expectations have collapsed is to 'kitchen-sink' the Q4 report and sandbag 2019 estimates. Under-promising early in the year can make 'over-delivering' easier if the economy holds together. The parade to the earnings 'confessional' could be fairly large. Netflix aside, nobody can raise prices in this economy.

Stocks got cheap enough to bounce into the seasonally strong first week of 2019. But now do they actually have upside from S&P 2600?

I'm like the Scottish caddie who looped for me last summer. When I asked him if 5 iron was enough into a stiff breeze, he said "I hae ma doots".

Rather than jumping on the increasingly crowded 'market low re-test' bandwagon, my view is crystallizing around a grinding, downward-biased move for stocks in the first half of the year. Although there is tons of cash on the sidelines, there will be no rush to re-risk portfolios actively until the economic deceleration is pronounced enough to create a policy more definitive policy reversal from the FED. The markets are already pricing that in. Problem is ... the FED hasn't said as much. So bring on the bad news!

And it may be already here.

If U.S. air traffic controllers have to rely on their fellow Moncton-based hoser brethren for their pizza, it would seem we are just beginning to see the negative effects of the shut-down. Hand-outs aside, the system could quickly grind to a halt if these workers go rogue and refuse to work. Delta Airlines is already complaining about a slowing of government worker travel. But think of the economic effects of a complete air traffic control system halt. How much $AMZN can I sell you?

Eurozombie

Now that the German economy is sharply decelerating and inflation measures continue to fall, the ECB has effectively missed the window for quick normalization of Eurozone interest rates. While the main market chatter has been about Brexit and the Italian budget, Mario Drahgi has been desperate to convince markets of the merits of his reversal of the stimulus that stemmed from his 2012 "whatever it takes" declaration.

Now with Brexit officially a shit-show, and given the moribund nature of the European growth outlook, he is painted into the same corner as always. The European Economic Union, not unified by a common fiscal policy construct, is unable to offer the stimulative equivalent offered by U.S. and Chinese tax cuts.

With European politics in disarray it's left to Drahgi to prop up the zombie-like Eurozone economy.

A crowded U.S. dollar long, combined with the recent downward repricing of U.S. interest rate forwards, has created the environment for a bounce in the Euro. The Euro bulls are seemingly unfazed by the real prospect of a Draghi about-face on policy hikes. Like the current stock rally, I would also fade any strength. Wake me up at 95 cents (circled).

Risk Model: 2/5 - Risk Off

The 2 week rally since Christmas rally has quickly improved investor appetite for risk. The market is no longer oversold. The RSI is already above 60 and actually in risk-off mode. The 200 dma rule is in risk-on mode, at a benign 2.7% discount.

Unfortunately, now that cooler heads have started to prevail, the opportunity for profit has quickly diminished. The AAII sentiment Indicator has recovered from the panic lows set in December but the signal line (30 wk ma) is still falling, indicating a persistent bearish sentiment bias.

AAII Bull/Bear Ratio

Similarly, the 3mo Volatility Index has come down to just above the signal line. Ominously, that signal line, the 200 dma, is still rising. The Index has bounced abruptly away from this line twice before, reflecting the twin threats of FED over-tightening and the as yet unresolved China tariff war, but the trend to higher volatility has yet to definitively reverse. Could the current government shutdown risk be the next volatility catalyst?

3mo Volatility Index

Most disappointing has been the action of copper vs gold. The risk-on players aren't giving us much support here. Judging from the chart below, are a long way from seeing a confirmation of a supportive global growth environment that could meaningfully extend the cyclical expansion. Without that critically important rotation, any market recovery in the near term is likely to prove ephemeral.

Copper/ Gold Ratio


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