Bounce Time?

Given the sea of ink recently spilled in an effort to 'explain' the recent market turmoil,

surely the battered bull brigade should be able to float a counter-attack. But don't blink, you might miss it.

The makings of a market rally are now in place. A multiplicity of risks, both macro to micro, have been trotted out and forensically inspected by various commentators and analysts. What started as a long over-due valuation adjustment provoked by the Fed's 'Come to Jesus' hawkish pivot, has been further compounded by reduced economic growth and earnings forecasts. Aided by twin externalities of an uneven Covid recovery and Russian hegemony, cost increases, primarily in energy and labour, are causing fresh downward revisions to corporate earnings forecasts. Lingering doubts about a persistent endemic virus and unspoken fears of further Russian aggression add to the fear factor that helped to accelerate recent declines.

The usual contrarian indicators that bulls rely upon are making their appearance. Advance/Decline ratios, %of stocks Below 50 day, and reported cash positions, chief among them. Add the following indicators that are reached extremes: Put/Call ratio, $Vix/$vxv, AAII Bull/Bear Ratio. And my favourite indicator of all - my retired buddies at the golf club, who, after not caring for two years are suddenly asking "what's wrong with the market, Deck?"

What's wrong is plain to see. The punch bowl of liquidity has been removed and financial conditions have quickly tightened. But that's hardly fresh news. Bearishness is fashionable now. Concern and pessimism are 'trending'.

Such is the perfect environment for a bounce. But a counter-trend rally is not a bull market. The catalyst for sustained equity performance is actually a slower growth economy that equilibrates demand with the now-reduced supply levels and lets the Fed pause the tightening. But the headlines needed to feed that salubrious narrative won't make for pleasant dinner conversation. Inflation is a pernicious enemy. Price controls and rationing proposals that harken back to the failed 1970s 'WIN' (Whip Inflation Now) campaign don't work. Only tight money - the tough-love of economic policy - can solve this in the long run. Just Google Paul Volker if you don't believe it.

So you can 'play' the market for now. To generate some temporary upside we will need a bit of 'good' news. A pull-back in the U.S. dollar? A seasonal drop in gasoline? A bullish forecast from a trusted market maven? Who can say? These are the typical 'known unknowns that traders often latch onto as bounce-trade catalysts.

This morning's Retail Sales numbers are somewhat comforting and seem to be supportive of risk-taking for now as a recession is taken off the table. But there are reasons to discount the sustainability of this strength, especially if oil prices jump higher and keep squeezing the consumer. It takes time for the tightening in financial conditions to fully pass through to consumer spending.

My take is that any rally based on positive U.S. economic news is suspect. The Fed has started the process of normalization of rates from too far back and too late to easily tame the inflation/stagnation narrative that is the base case. I always thought the economy would decelerate at some point this year but remain positive. That was before the twin shocks provided by Russia and China. If there is positive news from either of those regions it would actually be good news for stocks as it would improve the supply side part of the equation. But that is a tough ask for now.

There's a ton of cash on the sidelines but some of it has come from a reduction of bond holdings as the time-honoured 60/40 stock-bond allocation has spectacularly failed many a prudent investor. I believe a now chastened retail investor will start to deploy that cash in defensive asset classes, especially in the high-yield and investment-grade spaces now that yield roughly the equivalent of long-term inflation expectations.

Welcome to phase two of the correction. Time to sort winners from losers. It will be a choppy summer at this rate but that's better than straight down.

Rick Przybylski

As some of you may know, the redoubtable Rick Przybylski suddenly passed away this week. In the early parts of my career, and like many others in the institutional equity business, Rick was both a mentor and a friend. The revolutionary quantitative programs that he pioneered guided portfolio design and monitoring for many Canadian pension funds and I was fortunate to be an early adopter and long-standing client. There are many success stories today that were built on the foundation of his investment acumen and innovation.

Beyond the contributions to the investment industry, he was a devoted husband to Marni and a loving father to Karly and Tania. His ties to Credit Valley Golf Club, where he often held court, were deep. After happily sponsoring his application, I watched in awe as he integrated himself into all facets of CV life. There will be many a teary-eyed member at tomorrow's Men's Day, an event he virtually created and championed so well.

RIP 'Ricky One-Vowel', we will miss you.

Risk Model: 2/5 - Risk Off

The price recovery that started last week is so far holding. The Model will again lag this rally as the non-price variables, VXV, AAII Bull/Bear, and Copper/Gold have a lot of work to do. This rally is not to be dismissed out of hand though. The averages have the potential to test of the 200 day at least. The key chart to watch is the 3-month VXV (below). The uptrend needs to be definitively broken before I will call the resumption of the bull market a fact.