Bottom's Up!

OK, OK, I get it. The correction everyone wanted is here. That can't be bad for those who have waited for an entry point for a market they missed. But are they now willing to pull the trigger, or are they as confused as the talking heads on TV who have no clue? After getting the market spectacularly wrong last year, Mike Wilson of Morgan Stanley said as much on Bloomberg - he has no idea!

As the Leafs did last night, we snapped the losing streak yesterday. And like the Leafs, markets may surprise to the upside this time. The short and sharp call I argued for last week has played out. The catalysts are well-known. Fixed income yields backed up but are stalled at 5% on the 2 years, as bondies await the Treasury refunding and the PPI on Friday. Tesla's meltdown ( I just saw a 'death spiral' call!) and Apple's China problem are front-page news. Geopolitical fears have subsided after Iran's humiliation over the skies of Israel. Any pre-election jitters in the U.S. won't kick in until the conventions later this summer as people remain mesmerized by Trumpian legal follies. Tell me something I don't know.

But we need a catalyst for any renewed upside. What will drive investor expectations now? The pendulum has swung 180 degrees from October's recession call and its attendant 7 rate cuts to the current "no-landing" scenario that has reduced the expected number of cuts to 2 or fewer. Isn't the truth somewhere in the middle? If it is, my "buy bonds" call from last week should continue to work.

And I love that U.S 10-year yields peaked last week on - wait for it - Tuesday at 11!

The reporting season is shaping up as a mixed bag after the U.S. banks showed wildly divergent numbers and today's reports are all over the map. That portends a choppy sideways phase for stocks after the recent multiple-led rally that must be back-filled by earnings increases or risk a further downdraft. This period of sorting out is always healthy, except for the investment analyst whose buy recommendation gets smoked from a company's earnings miss. At the macro level, the puts and takes all even themselves out. However, the market should rebuild its upside momentum as financial conditions and fiscal policy remain supportive for a continued soft landing.

My best guess is the correction is almost over before it began. Markets will play out in a choppier fashion with elevated stock-specific dispersion as we head towards a possible May top. But it's a market of stocks now, not a stock market. The macro drivers are unlikely to change the narrative meaningfully until later this year.

Sector performance during the correction is usually a good 'tell' on future market leadership change. The regime change to a more inflation-prone environment is evident in the trend change of two important sectors: Financials and Materials (shown below) against the now fading leadership XLK - technology group.

Financials and Materials vs Technology - S&P Groups

As with any transition, there may be bumps along the road. Financials still need to deal with the embedded problems of CRE vacancies and deposit/asset mismatches from the inverted yield curve. Energy and Materials, with their high-volatility commodity drivers, usually require synchronized above-potential global growth to refocus investors' attention away from their quality/value/low-volatility home bases. China, despite a stronger-than-expected Q1 GDP print, is still a wild card for the commodity markets.

I don't expect this leadership to develop seamlessly, but with the current rate of fiscal debasement of fiat currencies in the major economies, there is a compelling argument for hard assets the likes of which I haven't seen since the late 1970s. Oil, Copper, Gold, and Bitcoin are all holding up well despite the soaring U.S. dollar. That tells me I'm not the only one looking for a diversifier from financial assets whose values are determined by the short-sighted profligates in charge of the global financial system.

A further tailwind for investment in these groups, left for dead by ESG-driven thinking, is the massive underrepresentation in investor portfolios. S&P weights for the entire Energy and Materials sectors are less than the combined sum of just three stocks, Apple, Microsft, and Nvidia. By definition, passive index players in the U.S. market will be chronically undiversified for years to come. Only from an extended period of underperformance, will passive strategies lose their current domination of eclectic stock-picking, but I believe the worm has finally turned.

The Fed will eventually get the data needed to attain its goal of a normalized rate environment this year. The bifurcated economy resulting from income inequality has masked the underlying weakness of consumer credit, especially at the low end. Yes, people are working, but with the price of shelter and food having reached a high pain threshold, they have to! The loss of momentum in the fiscal stimulus from Covid combined with the lagged effect of higher rates will slow spending this year. Employment won't be far behind.

That should swing the pendulum back towards easing and the rally will restart. Leadership should look different, but the market should regain the highs. Recent relative strength shifts are instructive.

Ok bottom-up players, over to you!

Risk Model : 3/5 - Risk On

Well, that was quick. The model is happier now that the Copper/Gold ratio is back above the signal line. And, as I pointed out last week, the AAII Bull/Bear ratio has returned nearer to parity, relieving the overbought pressures that built up during the Magnificent Seven mini-bubble. The trend for sentiment is still up and the dips are a contrarian entry point. The rest of the market is looking OK and tonight we get the Tesla earnings litmus test for the stubborn growth junkies. It should be more interesting than Trump's sordid soap opera. Musk has some 'splainin' to do!

AAII Bull/Bear