Death Zone

When mountain climbers dare to ascend above 26,000 feet, they enter a zone where risk of sudden death is omnipresent. In those rarified heights, oxygen levels 1/4 of normal levels subject the human body to the risk of life-ending stroke or pulmonary edema. Worldwide, there are only 14 such peaks above this dangerous level, so they are rare places for human beings to travel.

Mountaineers know the risks, and yet they continue to climb them, driven by the euphoria of summiting. Last year, on Mt. Everest, 11 climbers died in the death zone due to crowded conditions. As eco-tourism has grown in popularity, and without any self-control from authorities greedy for access fees, risks of catastrophe have multiplied on Everest.

You know where I'm going with this - don't you?

Microsoft - the Mt Everest of the S&P 500, as well as a handful of similar large growth stocks are drawing ever more climbers. Having just been resupplied with supplemental oxygen in the form of lower interest rates, investors have been re-energized to push these stocks to new highs. Summit fever has hit Wall Street.

It is not surprising that long duration equities - mainly mega-cap Growth stocks - have regained leadership. They ceded the leadership crown temporarily late last year as investors bottom-fished the lagging cyclical and economically sensitive areas and sold bonds. Due to a sudden demand shock from Coronavirus this turned out to be a false start. Frustrated portfolio managers (and retired bloggers) who yearn for a rotation away from the pricey growth leadership are left to again wait for a Godot-like economic acceleration that never seems to come.

This TINA-driven push has created a valuation risk similar to the oxygen starvation risk faced by real world mountain climbers. Sudden drops in the rate structure, driven by equivalent declines in inflation expectations, have once again pushed yield starved investors back up the same risky slope as in prior episodes of economic weakness. Forward PEs of the popular growth stocks are routinely above 35x, thanks again to a 1.5% ten year yield on U.S. Treasuries. And good luck valuing TSLA. The appropriate metric is, as in the last bubble, 'price-to-press-release'.

The economic hard stop brought on by Coronavirus is only affecting the weaker sectors, Energy, Materials and Financials, just as oxygen deprivation disproportionately claims its victims from the weaker climbers. Last week, commodity stocks revisited their lows and capitulatory commentaries multiplied. Energy stocks acted like death.

Although the effects on the economy are real, the sudden deceleration is widely perceived to be transitory. Hence the rapid return of confidence on the part of dip-buying stock bulls. But the narrowness of the advance is disconcerting. Mega-cap leadership is masking the breadth and volume non-confirmations that are troubling technically.

Embedded in the decision to drive stocks higher is post-virus recovery, but this is a huge inconsistency. If the preferred scenario of the bulls is a "V" shaped recovery, how can interest rates remain so low? Stimulus measures from central banks, if effective, will reverse at some point. The 'bad-news-is-good-news' stock market will be at risk.

Fast forward to the second half of the year when the full benefits of the multiple rate cuts and the forgotten trade wars start to take hold. Will economic deceleration still be the sentiment driver it is today? And if there is a gradual lessening in the fears from the Coronavirus over the next few weeks, won't investors be incentivized to take profits on the winning trade and again bottom fish the laggards.

So by any measure the "market" is not where the risk is. It is a bi-furcated index with big cap tech and consumer discretionary (APPL, AMZN, NFLX etc) leadership masking a huge buying opportunity in value and cyclical equities, should the liquidity fix actually work. They are down anywhere from 15 to 25% and hugely undervalued. If the risks to the economy were so high from Coronavirus, why are corporate bond spreads so tight?

As with the crowded peak on the mountain getting riskier by the minute, it seems prudent to focus on those equities left behind in 'base camp" - like banks. The death zone climbers are the ones that are taking all the risks. Some of them may not come back alive.

Risk Model: 3/5 - Risk On

With the XIU only at 67 RSI and just 7% above the 200 DMA, the market is not overbought enough to give a sell signal - but is getting closer. Combined with a tame VXV (3 month volatility) index, and a risk-on signal is now being mechanically produced. I'm not so sure.

I'm waiting for a sign of rotation that will provide an entry point for the banks. Today, a rising 10 Yr bond yield today is a start. Just getting back to a zero 'real' rate of interest would mean a 20 basis point rise from today's virus panic levels. Any sort of 'good news' on Coronavirus can provide such a move, whereas an unexpected escalation of the disease could spark more fears and delay the rotation. Over to you, CDC.

The AAII survey this week may actually support risk taking when it is revealed on Thursday as people this week have gotten more optimistic. The lowly Copper Gold ratio is revisiting the 2016 levels - the last time global growth was similarly challenged. No rush there, but if I had to buy something for the next ten years it would be FCX not NFLX.