Dimon Dogs

Bank stocks have always been one of my favourite indicators for divining the direction of the market. They have the dual role of helping to anchor many of the valuation parameters for stock markets while simultaneously exhibiting earnings cyclicality that reflects current economic momentum. They are 'soft cyclicals'.

They need to do better.

Last month I recommended JP Morgan as a play on the recovery in investor sentiment after the August mini-meltdown. After Trump's tariff escalation, the safe haven bond market had bubbled up, causing the yield differentials for banks to become wildly attractive for income starved investors. Dutifully, JPM rallied 15%. But does a strong bank rally indicate an economic recovery - and more importantly, the soft landing of global growth?

I have to say that the jury is still out.

Confirmation, from a technical perspective, is lacking. The corroborating indicators I like to use failed to make fresh highs with the price of JPM. The top three panels; Relative Strength, Chaikin Money Flow and Accumulation/Distribution - all failed to make new highs with the price break-out. Close but no cigar.

JP Morgan

For his part, Jamie Dimon, head of JP Morgan has done all that he can do. The cash return story at his company is a model for this market. All he had to do over the last three years was triple the dividend/buyback metrics of the company and voila! - the stock was a double. The tiny yields afforded investors in fixed income can't possibly compete with this juggernaut. Buy JPM on this pull-back.

Unfortunately the same cannot be said of many of Dimon's competitors - the Dimon Dogs. Although, up smartly from the 2016 lows, most banks stocks look like Bank of America, show below. There has been no progress in the last two years, despite the improvement in balance sheet and stable credit conditions. It has all been undone by the flat yield curve environment and weak capital markets.

Bank of America

Bond market strength is likely to stay with us for a while, sapping equity performance. My one of my favourite macro strategists who covers what's left of active portfolio managers in the declining world of Bay Street, Martin Roberge of Canaccord Genuity, has postulated that corporate stock buy-backs have accounted for the lion's share of stock price performance over the last few years. As investor pessimism increased over the past number of years, corporations have more than matched the ETF and mutual fund redemption surge by Hoover-ing up their own equity.

The mismatch between loose monetary and tight fiscal policies in the Eurozone continue to force non-U.S. players into the Treasury markets. Although huge issuance has sated the demand recently, causing a bit of a give-up in price, bond buying is still strong. It follows, therefore, that risk markets have started to freeze up. A Google search of the word "recession" spiked noticeably last month, reflecting the pessimistic tilt in investor mindsets. The IPO failures of recent weeks are a case in point.

So despite huge issuance in fixed income markets, the bid remains firm. Massive budget deficits are being gleefully cheered on by politicians who, seemingly unburdened by fiscal discipline, continue to spend like drunken politicians. But income starvation is rampant in the land of the investing public. Bonds will continue to dominate the asset preference of many investors - especially in the U.S. markets. Stocks have become a 'plug variable' to the investment equation, good only for the income they produce. Hence the sideways price action that has thwarted the bear case.

The investment landscape is a mess. No amount of behavioural economic analysis can predict the next year's outcome. And the dizzying lack of economic certainty has risen today with the legal rebuke of Boris Johnson's actions to muzzle the UK parliament. The dangerously unstable game of Russian roulette in Britain rolls on.

Add to that, there is a credible groundswell of support for a Trump impeachment, following his blatant attempt at coercion of the Ukrainian leader - an irrefutably impeachable offense. The U.S. safe haven story is illusory. But for now the bid, most notably in the U.S. dollar, is still solid.

Maybe Canada is still immune. Our leader may be a fanciful idiot, but he's hardly a crook. A Bloomberg article on Canadians being better off that their U.S. counterparts is getting a fair degree of traction south of the 48th parallel.

I'm still in a wait-and-see mode until the risk model kicks in definitively and the rotation from bonds to stocks resumes. Dr Copper has not changed his forecast, despite the 'hope' rally of the last few weeks. The potential of a rotation away from defensives/growth towards value/cyclicals is tempting but not supported by any evidence as yet.

The positive readings from the Bloomberg and Citigroup Economic Surprise Indicies (below) have been encouraging lately . But they been skewed by the recent capitulatory environment that flowed from the trade war escalation. Similar to the post Trump election surge, such extreme readings tend to mean-revert, once sober second thoughts sink in. Analysts have been too bearish lately.

Economic Surprise Indicies

Consumer spending is still being supported by easy money and strong employment. But this needs to be augmented by business investment and capital expansion for the resumption of the cycle to truly be confirmed. I fear more bad news will be needed to prompt policies that support such an outcome.

Sorry Tuesat11 fans, the risks in October usually outweigh the returns. No Dimon Dogs for this classic rock fan.

Risk Model: 3/5 - Risk On

Despite the recommendation from the model, I think it is still too early for risk taking. I am suspicious of the bounce in AAII sentiment that followed from the lessening of trade tensions last week. The declining trend of the ratio, and its attendant falling moving average is a formidable obstacle to the longer term resumption of a positive risk appetite environment. Buy the next dip, but don't chase the market here.

AAII Sentiment

As I said above, Dr Copper is still recommending a dose of defense when it comes to cyclical risk taking. Keep a close eye on this one, as it will be the first one to go green once the economy actually improves.

Copper/ Gold Ratio