Baked In

It's all over but the shouting. A trade deal with China is close at hand. The "great deal - a really, really great deal" will soon be trumpeted by a vote-hungry President Trump to a nation starved for good news. Consumer confidence will soon soar, pushed by the wealth effect from rising stock prices. Companies will soon invest aggressively, eschewing their preference for growth-dampening stock buy-backs. This will cement the cyclical turnaround in the world economy and unleash a rotation to the left behind value, commodities and emerging markets segments. Bond yields will rise along with inflation expectations. Stock markets will broaden out and volumes will pick up as the last skeptics capitulate and chase the reinvigorated rally to new all-time highs.

OK, a guy can dream can't he?

Reality check. The recent rally has stalled badly. The above scenario is nowhere to be seen. Bond yields have dropped 20 basis points since early October, taking the yield curve to its flattest in two months. Copper prices have quietly marked time for a month now, refusing to break above the critical $2.75 level. Volumes into stocks have been pathetic. Bond funds resumed their inflows last week. AAII sentiment readings are back to neutral.

The naysayers seem to be gaining ground. Although there have been nothing but encouraging words emanating from both camps from the trade talks, market pundits are still cautious. Calls for a pull-back in the averages have been as numerous as Taylor Swift AMAs.

But consider an alternative narrative: the pull-back is almost complete.

There are two ways to correct a market, time and price. Could this market pause be a case of the former? Internal measures of breadth, after making new cycle highs, have recycled into a neutral lull. The early October cyclical leadership has abruptly paused to wait for the highly anticipated 'Phase 1 Deal' to actually be signed. Stocks have underperformed bonds for the last two weeks. The recent highs were dominated by the tried and true leadership of mega-cap growth stocks. The equal weighted market (see below) has pulled back as well, testing last month's relative low. This is corrective action for sure.

Equal Weighted ETF ($RSP) vs $SPY

So fear not dear investors, the rally is still intact. It's just marking time. A muted VIX, dovish FED and better-than-feared earnings have created heightened investor confidence. After months of negative headlines, and with a risk-off suicide switch in early September's bond yield collapse, risk-on behaviour is winning by default. The benefit of the doubt has switched to the bull scenario. Most importantly, a reinstatement of a positively sloped yield curve is signaling a successful soft landing. Deal with it Rosenburg.

Investors have seemingly overplayed the geo-political dramas of the past year. They forgot the main driver of asset price performance: globally synchronized easing by central banks. Stocks are always and everywhere a monetary phenomenon. Ignore that at your peril.

But are we out of the woods yet? Hardly.

The S&P 500 has moved on a narrow group of mega-cap growth stocks. Year-to-date, fully 25% of the gains have come from AAPL, MSFT, FB, GOOGL and AMZN (Microsoft having replaced Netfix in the now-obsolete FAANG).

Importantly though, as Julian Emanuel of BTIG Research pointed out, market breadth has confirmed the advance. The chart below shows a new high in breadth (top panel) for the market recently.

Cumulative AD - NYSE Stocks

The risk model says it all right now. Tactically, the stance in this market is full-on bullish.

Only a black swan event (that each investor should always keep in their back pocket) can derail the bull market now. Should an unexpected renewal of a harsher tone in the trade talks provide a sharp correction, I would add to the risk-on positioning. But the correction camp is very crowded and we may not get our wish. But just in case, insuring one's position here with cheap VIX insurance or put protection seems prudent.

A deal that propels the economy back into high gear is a tempting scenario, but is far from done. Although Trump loves touting a rising market and the election race is heating up, we can't dismiss one last ditch attempt at gamesmanship from the Orange Oracle of Mar-a-Lago. Like most investors, I just want it all to be over!

Risk Model: 5/5 - Risk On

What about risk on don't you get? The deck is stacked in favour of the bulls. Slightly bullish AAII sentiment readings and the Copper/Gold are holding in well in face of the many second guessers. The depressed level of volatility is all the more remarkable given the impeachment drama and the Hong Kong unrest. The RSI overbought levels have gently receded to neutral. The tape is quiet - too quiet for some.

Insurance is now cheap. I don't expect that we need it - but no one ever does just before the fire.