Gorilla Hill

The market is forever filled with challenges for traders as we head towards the bull market finish line. My friend and mentor Horst Mueller called this the "struggle phase", and for good reason.

Over-accomodative monetary policy, especially in Japan and Europe, created an uneasy feeling for risk takers. Does the bond market know more than the equity markets about the future? Are negative yields a harbinger of global recession? Are we talking ourselves into a slowdown that will spiral out of control?

But just as evidence of the effects from the tariff wars were being reported, a sudden 4 day rally ripped the face off the recently emboldened bears. Bonds, topped out in price causing their defensive equity brethren groups, Utilities, Staples and Reits that had been August's winners, to lag badly.

In a classic reflationary leadership rotation, oversold laggards performed best during the bounce. Basic Materials, Energy and Financials led the climb back up the market hill. Unfortunately, it remains yet to be seen if this is a sustainable rotation. In the short term, I doubt it. There is more work to do.

A simple chart of the relative performance between stocks and bonds, shown below, gives a clue as to the possible outcome. Although stocks have been generally positive over the past one year period, with the S&P 500 up some 7%, they have lagged the bond market. A choppy downward sloping trend, with some notable counter trend moves, has played out. With each sentiment-shifting tweet from the White House, the prospects for the two asset classes have violently zig-zagged.

SPY/TLT Relative Performance - 2008-19

The chart is bouncing off an oversold level, but needs more work to confirm that the major uptrend has been tested. The upward path, like a steep hill, is punctuated by pull backs.

Last Sunday, yours truly participated in the 100KM bike ride in Milton know as the Epic Tour GTA Granfondo. At the 93 km mark, the route sadistically takes you up the side of the Niagara Escarpment on the 'Gorilla Hill'. The photo above doesn't do it justice, with the flattening effect of the camera. It is a killer 9% sloped road that sees many participants sheepishly walk their bikes to the top.

Your humble scribe, in the words of the cooking game show - "NAILED IT".

Wisely, I had paused at the bottom the regain my strength while others, who blithely cycled passed, came to halt half-way up the monster climb. Of course, having a brand new carbon bike didn't hurt, but the effort to gain the peak was exhausting and exhilarating.

Hopefully the recent events (Brexit & Tariff wars) that have slowed economic growth to a relative crawl are just a pause at the bottom of the economic hill. As the chart above shows, there have been three previous consolidations since the great financial crisis in 2008-09. I expect this one to resolve favourably as well, given the health of the credit markets, financial strength in the banking sector, and not least of all, global central banks' easy money regime.

Uncertainty is at its maximum right now with both Brexit and China trade issues yet unresolved. Just getting closure on the two issues alone should be enough to flip the second derivative of global growth to the positive sometime next year. I believe we have already passed an important point of capitulation for risk appetite from the sentiment standpoint.

The extreme consensus thinking around gold is marking an important inflection point. Record long futures positions show clear signs of exuberance. Copper similarly signaled a reversal by rising smartly as shorts scrambled for cover last week. The haven trades were very crowded.

So I am still patiently waiting for the model to positively inflect. It should take some time here as the deceleration in growth is still ongoing. There is still room for the chart above to "coil" before lifting off. Last week's leadership rotation is a canary in the coal mine.

The Gorilla Hill awaits. Only the strongest players will dare to climb it. The rewards are pretty sweet though.

Risk Model: 2/5 - Risk Off

As discussed last week, the slower moving components of the model, while improving, have yet to blow the all clear.

The XIU remains stuck in a sideways pattern, meandering between $24 and $25. The RSI is similarly stuck in neutral at 55.

The copper gold ratio, after a severe four month sh*t-kicking, is now rising to the signal line. Encouraging, but a bit too soon to be 100% confident.