Blame Duck Session

Two weeks ago seems like a lifetime. The uncertainty surrounding the election, combined with worsening news on COVID, had pinned the market in a defensive corner. The WFH trade that has dominated the market's leadership remained elevated and popular. And last week, the uncertainty created by the U.S. election resulted in a knee-jerk rally in growth stocks. My call to go all-in on the reflation trade seemed premature.

Then along came the Pfizer news.

Suddenly the investor playbook changed dramatically.

Sell: NASDAQ - Bonds - Japanese Yen - COVID plays - Gold

Buy: Russell 2000 - Airlines - Casinos - Office REITs - Copper

I seem to recall recently saying, somewhat facetiously, to put on a pair trade: long Delta, short Zoom. I only wish I had done it! Although to be fair, I did have a 120% long position in the value trades such as VOOV, KRE and EEM. I will be taking profits on that trade now.

The squeeze play, long overdue, has now produced a short-term risk of a pullback. In fact, yesterday's late fade was a telling move. With the news of record levels of COVID infection rates and a political standoff in Washington, the markets lost their nerve into the close. The good news on the medical front, although a huge positive, will allow mass immunization and treatments to reopen the economy - but only later next year. Between now and then, we are still facing an accelerating pandemic with the potential to shake the confidence of investors. The phrase "look over the valley" comes to mind, but it's a grim one at that.

So do I recommend selling? Hardly. I do think the shakeout will be bumpy. A strategy of buying dips is likely to be rewarded in time, but the transition to a successful reflation is 'fraught with risk'. We are now heading into a seasonal surge in communicative diseases and, perversely, the average citizen is now less likely to heed warnings about personal mask-wearing now that the promise of a vaccine is on the table. U.S. Economic momentum is still waning into year-end and a quick transition to the Democratic Administration is being drawn out by a delusional hope on the part of Donald Trump that he can still win. Mitch McConnel is siding with Trump for now, but that seems transparently partisan, and he well knows it. Pres Cheeto now vindictively lurching around his White House lair, tweet-terminating the last few enemies who opposed his crumbling kleptocracy. The Lame Duck session is turning into the Blame Duck session. It's reading like a bad script from 'The Apprentice'.

For markets, the pain trade is still higher. But a blanket strategy of indexation will be less rewarding. With the Mega-Cap growth trade stretched and over-valued, the broad averages will be challenged by competing forces. And the new threat of increased regulatory scrutiny, not just in America. China is after BABA and the EU is slapping fines on Google and Amazon. Public opinion is now turning on these perceived monopolists. Zoom may be wildly overvalued, but in this slow-growth era, full of disruption, technology stocks will still be well worth owning. Value just needed a catch-up bounce and it's getting it.

From a fundamental perspective, deep cyclicals, most notably energy and hyper-cyclical consumer discretionary like travel, are a long way from being out of the woods. This bounce has the smell of short-covering. The steepening yield curve and improved sentiment about a vaccine is a necessary component of the rotation but, we've jumped the gun on a full risk-on stance. Financials still lack a compelling earnings growth story.

Fortunately, we are still a long way from seeing a hawkish FED. I'd be more worried if U.S. bond yields reach the 1.5% level. For now, the bull market that started in March is alive and well. Blame away, but it ain't gonna change anything.

Risk Model: 5/5 - Risk On

All systems go on the model now that the AAII crowd has come out of hiding (chart below). As I suspected, they were waiting for a more definitive line of sight on the prospect of a vaccine before committing fully to the trade. They had stayed net bearish for a record 7 months!

It appears the copper/gold ratio (also below) is in full agreement too with perma-bear goldbugs in full retreat. I still think gold could be back in the driver seat in due time if further economic weakness prompts new rounds of QE. Stay tuned.

AAII BULLS/BEARS

COPPER/GOLD