Light Switch

Once again Donald Trump has flipped the switch.

The market's response to last Friday's revelation of a 'partial' trade deal, sparked a sharp market reversal. Is this just a random bounce by a market still trapped between the competing forces of low rates and slow growth, or the beginning of a new leg to the bull?

Although we have been fooled before, the bearishly tilted market reflexively moved higher on the perceived positive news. Investors have been hoping for resolution of the trade/Brexit issues for months now. But they continue to huddle into bonds and bond-like assets in a risk-off position that leaves them prone to FOMO during such sharp counter-trend reversals.

Although impressive, the rally failed to follow through yesterday. Sober second thought has arisen quickly. It's not surprising given the low credibility of the source - the Trumpster himself. Remember the China phone calls in August? Fake news indeed. The Donald has been as reliable as a deadbeat dad. He regularly sacrifices the truth in his transparent efforts to buoy up the stock market.

On CNBC yesterday, Flying-Monkey-In-Chief Steve Mnuchin, described the trade deal as a "phase one" agreement. This was received as 'good' news by a hope-starved stock market. Shouldn't we be getting on board this market?

I think not. As my daughter-in-law would say... "busy".

So, like long-suffering Leafs fans who annually set out lawn chairs on the parade route, the U.S. administration has jumped ahead of the story, trumpeting a trade deal like it is a fait accompli. A bit of a stretch even for this administration don't you think?

What good is a partial deal that just papers over the cracks? It's just kicking the can down the trade route. Forcing the Chinese to buy a few cargos of soybeans won't magically create enough long term confidence to regenerate a global investment cycle. And what about issues of forced transfer and IP theft, not to mention the increasingly fraught areas of human and political rights?

I can see as much downside as upside now. Monetary policy has maxed out its effectiveness. Globally, the populist politicians who control trade and fiscal policymaking are unlikely to fill the resulting void. There is still a ton of heavy lifting to do in order to generate a lasting turnaround from the decelerating growth spiral that prevails in the developed economies.

The sharp market reversal on Friday showed just how strong the bearish consensus has been lately. Last week's AAII bull/bear ratio (below) was near its three year low, reflecting the pessimism that has built over the past six months or so. These extreme lows demonstrate how stretched the sentiment readings have become. A bounce/ short covering, if not a seasonal low point, often arises from such readings.

The major U.S. banks are rolling out earnings this morning and they are mixed. Capital markets focussed Goldman Sachs missed badly. JP Morgan's numbers were a slight beat, unless you mark-to-market the hits they should be taking on failed unicorn IPO WeWork and the possible knock-on effects to their private equity portfolio valuations. Banks have tried to offset the decline in earnings growth by ramping up buy-backs but it has failed to raise valuations. The relief rally should be muted.

Unless global growth truly reignites an inflationary curve steepening, the rallies we are seeing in banks and elsewhere from the cyclical segments of the market are as binary as a light switch - one that is being controlled by the itchy finger of an increasingly isolated U.S. President desperate for re-election friendly news.

Advantage Xi. He could easily flip the 'off' switch and keep the U.S. in the dark a bit longer.

Risk Model: 4/5 - Risk On

The drop in the 3mo VXV and the improvement in the copper/gold ratio has given a mechanical risk-on signal. Although the benign condition is encouraging, I don't want to believe in this rally just yet as we are one tweet away from a reversal. I believe a bottoming process is underway but I would look for a test of the recent lows as confirmation that the worst is over. Copper breaking out above $2.75-80 would go a long way in that regard.

Sentiment is bombed out currently, hence I don't recommend many short positions here. I covered my July NFLX short recently, feeling that the bad news was out.

AAII Bull/Bear Ratio: 2017-2019

The focus of many asset managers has been on the threat of recession, hence the strong bond market. In the past year, since the Fed started to give up on their fantasy of a successful and smooth reflation of the U.S. economy, bond returns have dominated stocks. The relative performance chart below says it all. For disappointed investors, it's disheartening to say the least. All the more reason to turn off CNBC as if Joe Kernan wasn't enough already.

$SPY/$TLT Ratio: 2017-2019

The BofAML survey released today shows a pronounced crowding of the defensive trade. Fundamentally, the lack of inflation (see below), means that bonds have fully priced in the downward step-function in inflation expectations.

However, this could leave bonds vulnerable to a bounce in goods based inflation, similar to what was seen in late 2017, but we aren't there yet.

U.S. Inflation: Services & Goods