Bear With Me

Don't poke the bear. Not the stock market kind, but the Russian one.

Today, we observe a short-term negative correlation between two key asset classes, U.S. equities and the 10-year Treasury bond, in response to the sabre rattling in Eastern Europe. It's a classic flight to safety. In he short term, these two assets should act inversely to one another during periods of duress.

However, over a longer term, bonds and stocks should rise and fall together in response to the growth and inflation dynamics of the time. That hasn't always been the case recently. For much of the past decade, the term premium on the Ten Yr. has been suppressed by the Fed's slavish adherence to QE and ZIRP. That allowed for a negative relationship to develop after the COVID-19 growth shock. The effects of the Fed era of yield repression ran their course and produced the recent experience of rising stock prices and falling bond prices.

Those days are over. With fiscal policy dominating the narrative and the Fed less of a factor, the relationship that prevailed from the late 1960s to the late 1990s should be restored. That allows for a proper inter-market relationship to be re-established between the major asset classes.

The longer-term implications should be a return to positive correlation, and the impact on investor behaviour is essential to the new investment narrative. With its unfettered meddling in key economic policies, a Trump presidency should reinforce asset class behaviour more than Fed policy. Today would be a good start to correct this market in response to the more than 75 basis point yield increase in bond yields since last month.

We have already seen the currency and commodity markets react. The real question is: When will stocks wake up and smell the coffee? Nvidia earnings tomorrow may provide the sell-on-news excuse the market has sought since the Fed easing cycle began in September.

I believe the secular case for the bull market is intact. Still, given the elevated valuation and rapidly shifting narrative, we have to be on the lookout for short-term volatility. The bullish camp has grown too full of itself lately and has poked the bears with impunity this year. The Trump love-in on Wall St. petered out last Tuesday at 11.

Bear with me while I watch from the sidelines a bit longer.

Risk Model: 4/5 - Risk On

Again, this week, we face going against the model by waiting for a pull-back. However, the AAII data lagged by a week, and the price and volatility measures backed off from their pre-election risk-off signals. It's early yet to blow the all-clear. This market's overbought position still argues for some caution.

AAII Sentiment

Before making any risk-on moves, I would like to see this week's data first. The whipsaw weekly data mask that sentiment has been elevated all year since the Fed pivoted towards an easing bias. The post-election bounce was relatively feeble, reflecting investors' continued uncertainty over Trump's economic policy mix and its knock-on effect on risk-taking.

Copper/Gold

Trump's tariff threats have negated China's stimulation, which has been bad news for Copper in the short term. However, the longer-term thesis of EV adoption and dwindling mine supply is intact. Long-term thinking is always difficult, but the chart says it's time to accumulate a position in the base metals here.

Volatility

The bubble of 'election protection' has burst after the definitive Trump victory. Although notionally optimistic now, this indicator is starting to head in the wrong direction again.