V for Vague

With markets up 12% from from the panic lows of December, cooler heads seem to be prevailing. Although the trajectory of economic growth worldwide is firmly decelerating, the fears of recession look to be overblown. Aided by some reassuring reports from bank CEOs that all is well with the consumer, markets have rallied sharply, forming a pronounced "V" shape from their lows. In September, what had started as a normal correction in an aging bull market, quickly morphed into a crisis of confidence, leading to the dire extrapolations of recession from the likes of perma-bear David Rosenburg.

This looks to me more like a market correction that just fed on itself. But that is the role of risk markets. To create opportunity to profit from the fear of others. Some seized on that fear in late December and profited handsomely. But not many.

The FED has now been reigned in by the stock tumult. Although the final verdict is out, it would seem that they have gotten the message to slow the pace of their tightening. For the beleaguered Chairman, who claimed to be data dependent, the stock market has become the the biggest data set of all. So the market has put aside its slowdown worries for now by pricing the FED out. That may be somewhat overdone, but a slowing in the economy, aided by weakness in housing and the government shutdown, should allow the Chairman Powell the breathing room to hit the pause button on his policy remote. The bond market is helping, signalling a slowdown of inflation expectations. But, importantly, the yield curve has yet to invert.

So the focus of worry has shifted to the Global slowdown. This week, the professional hand-wringers on TV are fretting about China's report of 6.6% GDP growth.

China just printed a number that would be seen, in any other country, as a fabulous economic boom. But markets are using it as an excuse to gently roll over after the unsustainably sharp rally of the past three weeks. By completely ignoring the threat presented by the government shutdown, the market has demonstrated, yet again, its ability to get ahead of itself. Momentum algos I guess.

From the lows, the market has rallied into resistance that is defined by the rolling top formation traced out last year between 2600 and 2900 zone. Although it looks like a dead-cat rally, due to low volume, the likelihood of a retest is lessened by the enormous amount of unrisked cash on the sidelines, created by the December panic. Luckily, we are getting some economic misses out of the housing market that will reinforce the potential for a FED pause - ultimately a bullish sign. Any signs of a FED backtrack will make stocks look attractive going forward so - bring on the bad news!

But with recession talk, an economy in deceleration mode and geopolitical headwinds aplenty, what possible incentive is there for the market to proceed through that resistance and make new highs? I'm thinking that until the U.S.- China trade negotiations produce clarity, markets should drift slowly sideways to down for a now. A low volatility pause that refreshes perhaps.

In market terms, this translates into "V" for vague. We have no way to call the next move for stocks. Patience is a much needed character trait in this market.

A Flying V ?

Another "V" shape that is possibly in the making has my attention. The Copper/Gold ratio has been as reliable as any forecaster that appears on CNBC or Bloomberg. For a lasting recovery in risk appetite to occur, I believe we need to see an improvement in this indicator first. Back in 2016, it confirmed the successful soft landing in Chinese growth that ultimately lead to spectacular 2017 rally. A real economic Flying V!

A similar turnaround in this key ratio would go a long way to corroborating a global re-acceleration that I believe is necessary to make a meaningfully broad stock market advance. There is no risk-on signal yet, but stay tuned. Last week, Copper bounced immediately upon news of a rumoured breakthrough in the China trade talks. A bit of a tell?

Copper/Gold Ratio: 2014-19

Risk Model 2:5 - Risk Off

The interaction between volatility and sentiment has trapped the market in a box. Last week, the lagging AAII sentiment indicator went positive. This week it has dropped to negative, only to be replaced by lower volatility in its positive place.

All the while the market has become slightly overbought (RSI 67) and right back to the 200 dma. I've taken off most of the trades I put on from late December. I've got no bet either way here. There are too many calls for a re-test of the lows for me to believe it can happen.

I'm waiting for Dr Copper to give me the all-clear I guess. Economically sensitive stocks offer compelling value and they are basing nicely. Commodities have started to form bottom patterns after surviving last year's Fed induced dollar strength. All they need is a modest re-acceleration to assume leadership. I would look to emerging market economies to lead us out of this period of market vagary. Only they have the fiscal and monetary room to ease significantly.

If they do, then it could really be "V" for victory!