Lead, Follow then Get Out

Now that we have had a chance to analyze the recent fund flow data, it is obvious what has driven markets higher in the face of all the horrendous news.

There are more buyers than sellers.

Wow Deck, thanks for the cogent analysis.

But now that the Fed has outlawed rational price discovery, the market has a free pass to do whatever it wants. You give people free anything and this is what happens. With the announcement of a permanent put, the Fed copied Mario Draghi with a 'do whatever it takes' pledge. A quick check of the Eurozone economic performance over the last five years shows what that was worth.

The lack of discipline engendered by Chair Powell's 'get out of risk free card' is evident in the crowding. The vast majority of the ETF inflows have been into two types of issues - Mega Cap and Health Care - perceived winners in the dwindling equity bull. The rush to get in seems frothy.

Last week's AAII Bull/Bear ratio made a sharp low, effectively testing the historic levels set during the Great Financial Crisis of 2008. Bears were 2:1 over Bulls. But that survey was taken early in the week. Maybe they were talking their book, having sold down to their individual comfort levels. I know because I was one of them.

Then came the 'Great Reopening Rally' - one that continues as we speak. Hope is springing eternal now that we can survive this economic calamity unscathed. We are expected to believe all the restart hype just because people get to play golf again. Really?

The initial market leadership is rapidly fading as Mega Cap has paused and Materials, Energy, Financials and Small Cap stocks are now taking over. So the market is doing its best to put on a brave face and pretend like there is a 'V' shaped economic future just ahead. The followers are now the leaders.

Intermarket action would dictate that fixed income should now pull back from historically low levels. But in this brave new world of 'administered' risk markets, I wouldn't bet on it. The Fed is obscuring any objective reallocation of capital. They are standing in the way of markets, trying to send false signals.

I know what your saying. Don't fight the Fed! But without free markets, it's hard to stay positive. Now that Fed policy has extended into previously off-limit longer term markets, it hard to trust what the 'market' is saying. Japanese central banks have been buying equities for years - not that it has done much for their economy.

This market is anything but free - except for the cost of capital being effectively zero. Given the earnings deterioration from the Covid shock, anything above 2800 on the S&P 500 puts the markets back into the death zone of valuation that I discussed in February.

Force feeding from our friends at the Fed. What the F?

This looks like an old fashioned boiler room pump and dump - but without the dump. The Fed isn't a seller. It can't be. So as this next phase of capital misallocation runs its course, I anticipate that we will have a price to pay. Invest in haste, repent in leisure.

I'm not shorting this market just yet. The rotation trade has room to run. If people want to believe in a recovery enough to price one in - you shouldn't stand in their way. Usually, Banks kick off a recovery, as monetary easing marks the beginning of the end for loan loss provisions. My worry is that cheap money won't be enough to generate a robust recovery as long as the risk to reinfection and a second wave are present.

Bank stocks have lagged badly, correctly reflecting their hypersensitive cyclical earnings profile. They look like a great trade here if the restart trade gathers steam. But if that trade works, be prepared to get out again.

Risk Model: 2/5 - Risk Off

The model is likely stay lagged to the recovery rally. When it does go into buy mode, it will likely mark the end of the move. The AAII sentiment indicator should flip this week as evidenced by the the now renewed decline in the VXV and the generally bullish sentiment surrounding the 'restart'.

Importantly, gold is coming off the boil, having received a disproportionate share of the fund flows recently. Bank stocks are the laggard catch up trade now but their earnings impairment will be substantial and low rates and tepid loan demand will drag on earnings for years. It's a short term trade only.