Day by Day
Now what?
The markets have jumped the gun on the prospects for a trade deal and a soft Brexit - with both outcomes still in doubt. The actual details of either of these purported game changing events are mostly unknown and subject to last minute reversal. The 'hope' rally, that in three short weeks has pushed the market into overbought territory, is now stalling out. Calls for a correction are growing, as many technical indicators have flashed cautionary extremes.
My risk model says take it 'day by day'.
I know what you're saying to yourself, this is shamelessly transparent plug for my music, but you can't blame me. Now that Warner Brothers has cut their A&R budget, Zoltan and I aren't likely to get signed. Besides, Johnny Reid has hogged all the marketing dough for his Christmas tour.
After your obligatory download (copy paste the above link - Wix is too cheap to allow live embedding), it's back to the market. And what are we to make of this one?
Good investors need to stay flexible. When facts change you must change with them.
The key to the sustainability of the risk rally lies neither in a successful trade deal, nor a soft Brexit. Stock prices are a monetary phenomenon. Monetary conditions dictate asset prices to a degree that is hard to accept for most pundits and commentators. Weakness in stocks last year was due to Fed tightening and strength in stocks this year is due to Fed easing. Full stop.
The sooner one accepts this, the sooner you will lose the urge to;
a) watch CNBC for stock tips
b) listen to a guy who knows a guy who called the last sell-off
c) subscribe to a newsletter or blog (except mine)
This chart is the most important one. You have seen it many times before. It is Professor Yield Curve, who, along with Dr. Copper, is one of my two favourite economists.
U.S. Treasury Yield Curve: 10Yr - 2Yr
The past tells us to fear the market anytime the line is below zero (shown by the horizontal line above). It also tells us that the process of inversion is highly unpredictable. Inversions can take their time, as we saw in the 1990's. They can also be swift, as we know from the Greenspan era last time around. By recently bouncing off the 'zero' guardrail, the U.S. yield curve has pushed out the possibility of the recession that is so coveted by the bears.
It appears that the market likes the re-steepening of the curve, however modest. The recovery in risk appetite has been astonishing to some. But the behavioural asymmetry of investors - who are always three times as fearful as they are greedy - is to blame. Bearishness became fashionable this past year in response to the repugnant shit show emanating from the Trump circus of economic policy carnage.
But all along, the Fed had our back. And stock prices, although expensive, seem to have been given new life by the simple replacement of 'armageddon' with 'muddle-through' as the base case. I think the second derivative is now at work. The pace of decline has lessened, the PMIs have bounced. We can now look over the valley for a while. This is solely due to the reflationary moves of Draghi, Zhou, Kuroda and Powell. A vote hungry politician's only job is to get re-elected. Working out the mess that have created is now Priority1. Policy change has, consequently, inflected to the positive.
So, dear readers, it would appear that the pause that refreshes is here. It could be a sharp sell-on-news variety in response to the "good news" of a trade deal. It could also be rotational in nature, as the bad news of a weaker economy informs the short term risk stance recently adopted by the FOMO crowd. It could be a low-vol time correction that lulls the market to sleep, before rushing back up the Gorilla Hill of risk taking.
The rotation to full-on cyclical value has quickly petered out after an initial rush. The ebb and flow of trade deal headlines has seen to that. Power moves by mega-caps Microsoft and Apple are distorting the rally in favour of the growth sector. A higher degree of policy certainty, especially with respect to trade, is required to break this longstanding trend. Stay tuned.
Russell ETFs: Growth/Value
For an investor, there is a tough decision to be faced. Do I buy into the reflationary scenario that has been buoyed by recently eased monetary conditions? Or, as we hear most often, do I hope for a pull-back as I await news on the trade deal?
Either way, I recommend you take it day by day.
Risk Model: 4/5 - Risk On
Although the RSI is over the signal line, flashing caution, the market is only 5% above the 200 dma, not enough for a full-on panic.
The Copper/Gold ratio is weakening, falling back towards the signal line. This indicator is the most sensitive to the trade issue and could turn sharply in either direction on "good" or "bad" news on that front. Hence the day by day nature of this market.
Copper/Gold Ratio
Volatility is extremely compressed and could spring upward at a moment's notice. I said this is the "struggle phase" of the market - so having a bit of insurance is a good thing. Speculative positions are showing a 'crowded short' in the Volatility ETF which is concerning. But, as we saw in 2016, that condition can persist for some time and won't 'cause' a correction on its own. There has been a structural downtrend in place for a few years now as the popularity of the 'short vol' strategy has grown despite some abrupt reversals.
S&P 500 vs VIX Speculative Positons
