All Aboard!

I can't say I'm completely pleased with the recent vaccine-fuelled rally. Although there is no denying the positives from the medical breakthroughs, I think we are forgetting something here. Everybody had already expected it to happen. And if we know anything about markets, 'beating' them is hard. You always need to correctly expect the next set of expectations. So now what?

A dangerous bullish consensus wave was mounting even before the U.S. election sideshow played out. The vaccine 'light at the end of the tunnel' trade provided a financial endorphin rush that pushed the market to new highs. And in a text-book rotational move, the factor leadership alternated from Growth to Value. Previously sidelined investors have quickly jumped at the chance to turn bullish at all-time highs. ( see AAII chart in the Risk Model section)

But the voting machine that is the driver in the short term is pushing hard against the weighing machine that governs the long-run returns. Despite my positive outlook, I'm getting more cautious now given that the herd has run so hard. Markets have, as usual, double-counted the positives. By expecting a seamless economic recovery from a re-opening, while assuming that interest rates stay permanently fixed at current levels, the stock market seems to be saying you can eat your cake and have it too. Call me old-fashioned but that seems risky.

Just look at the inter-market action. Bond yields are still anchored well below recent highs, while stocks have broken out. As Sesame Street's Ernie said so perceptively "one of these things is not like the other".

Stock prices seem to be impounding the unlikely scenario of a smooth transition to a post-COVID era. The medical disaster currently unfolding is being dismissed as unimportant to the current feel-good asset melt-up. The political dithering and partisan ass-covering that continues to delay fiscal aid and improved COVID mitigation measures from the rudderless Trump Administration have been ignored. Nero had his fiddle, Trump has a five iron.

It seems increasingly like a good bet to take some risk off the table here. If we only get a pause and markets consolidate in an orderly fashion, there is no harm in taking a few profits. If expectations about the economy take a turn for the worse in the U.S., there could be a painful unwinding of the recent leadership rotation. The bond market seems like it wants to lean that way.

Sorry to be a Decky Downer here but the choppy path forward I have been predicting is still my preferred scenario for the next few weeks. A better entry point awaits.

Longer-term, I get it. A synchronous global recovery, combined with excess liquidity is a recipe for higher risk asset prices. I have waited patiently all year for the reflation trade to start up. But having seen the train leaving the station fully loaded, my bet is for a much-needed pull-back.

Risk Model: 4/5 - Risk On

The bullishness implied by the model is to be taken with a grain of salt. The RSI is in risk-off position - a sure sign of a market that's ahead of itself. While the Copper/ Gold ratio and the VXV 3-mo volatility and AAII sentiment survey are unambiguously positive, they are all stretched.

The over-exuberance showed by last week's AAII Bull/Bear ratio is extreme. After spending all year in the 'off' position, the survey respondents threw caution to the wind and recorded a 55% bullish reading - more than two Bulls for every Bear. It's a bit too much too soon. The last time this happened, in early 2018, the market spent the next three months correcting.

AAII Bullish Level

The Risk Model uses the XIU to identify the 'overbought' level of the market relative to the 200 DMA. It now sits at 8.5%, The equivalent measure of the S&P 500 is a nosebleeding 14.5%.

This is a level that has seen pull-backs before. I have circled the Chaikin Volume indicator (CMF). This indicator's action was thoroughly unimpressive over the two-week rally. Price moves unsubstantiated by volume confirmation are dangerous.

S&P 500