Fed Fake

The market has reached an inflection point of major significance. Measured by the S&P 500, stocks in the leading bourse are just below the all-time highs set last fall. I, for one, did not see that coming, given the pervasive deceleration of global growth and its effect on earnings. Valuation expansion has accounted for the entirety of the move as investors have made the mother of all Pavlovian reactions to the "Powell Pivot" in Federal Reserve monetary policy. I'm now left to wonder what's next.

With the fed fund futures markets actually pricing a cut to administered rates, and bond investors reaching for yield (Saudi ARAMCO 10X oversubscribed) the fixed income markets are getting frothy. What I see in bonds is a repeat of the FOMO top that we saw in the stock market of last year. The canary in the coal mine of a market sell-off last year was the lack of volume confirmation of the new highs being set by stock ETFs. Using a CMF indicator, we can see the exhaustion setting in after the huge move in bonds since the fall. We are getting a sell signal in bonds now. (below)

iShare Bond ETF

So if the stock market has risen in response to a passive Fed and the reach for yield has been a tail-wind for stocks - does it follow that markets are vulnerable? It depends on which market you are talking about. Leadership has mostly come from the Tech sector as well as Utilities and Reits. The Value components, Financials, Materials, Industrials and Energy have lagged.

XLK - Technology ETF Relative to S&P 500

Growth stocks have responded appropriately to the current environment of lower rates and a scarcity of growth alternatives, especially from the more cyclical sectors. They are now the most vulnerable they have been since last September. The successful reflation of global growth environment now being loudly signalled by Chinese stock markets will hurt the bull case for bonds. Growth stocks are negatively correlated with bond yields. The current spate of tech unicorn IPOs is a sure sign of a market peak.

We can only make lasting headway if the lagging sectors get a dose of rotation. But is the rotation to more cyclical sectors ahead of us or is this just another year of economic disappointment and the FED still in charge of our stock return destiny? Is the recent rally just a fake-out?

Commodities are giving it the old college try with copper setting up for its seasonal run into May and oil now joining the party. Both have moved higher after visiting Q4 lows on a reversal of now widely dismissed recessionary fears. Both commodities are anticipating a benign outcome of both the Brexit mess and the Trump tariff tantrum with China. This morning's Trump rant has put the Eurozone in the crosshairs that China is soon set to vacate should the U.S. China trade deal get signed. He's desperate to have a political piñata for the upcoming election run and, now that China is playing ball, a febrile Eurozone will do quite nicely.

I view the potential of a cyclical bounce as a sentiment head-fake. Should we see commodity markets at seasonally induced highs over the next few months, I will gladly be selling the news. The economy has too many secular challenges such as weak demographics, stretched fiscal positions and divisive political turmoil to sustain any kind of strong growth. The top in this market will be visible once bonds start to back up in response to the cyclical bounce off last year's lows.

A FED rate cut, in my view, is an unlikely event. Even with the potential of Trumpian acolytes, Stephen Moore and Herman Cain, being added to the Board, it won't stop Powell from reversing his dovish message at the first opportunity. He needs to regain some sorely missing street cred after seemingly being badgered by Trump into his 'patient' pose.

So in a reversal of the last six months, where bad news was good news, a move higher on better economic data should mark the beginning of a topping phase for equity markets. Bonds will lose their haven status quickly and the dollar will rally, choking off any nascent global economic spurt. Reducing equity exposure for cash and alternatives would seem a prudent course of action going into next fall.

Meantime enjoy the FED-fake!

Risk Model: 4/5 - Risk On

Although AAII sentiment pulled back, it held above the moving average signal line. Volatility is dormant and the Copper/Gold ratio, while sluggish, is supportive of the reflation scenario.

Like last week, the RSI is signalling an over-bought condition, but that can be sustained for a while longer, especially if the recent catch-up moves in financials and energy equities is combined with a pause in the tech sector.