Buyer's Remorse

Our gentle geriatric Robinhood, Joe Biden, and his merry band of Democrats have repelled the evil King's attempted counter-attack. They will soon be in charge and all will be right with the world. Markets now seem confident that U.S. exceptionalism can, once again, be counted on to lead to an era of peace and prosperity. The 'look over the valley' crowd is back in control today, after taking the past month off for some well-earned vaca. The bit is firmly back in the market's teeth this morning, following Treasury Secretary Janet Yellen's pep-rally testimony to the Senate and the beginning of a largely positive start to corporate earnings season. All seems peaceful in the Kingdom.

I'm thinking: Be careful what you wish for.

Stalled by the change of leadership process, and with the usual implementation lags, the promised stimulative policies are likely to be 'too much too late' with second-level effects that the market is yet to appreciate. But give it time, it will.

The fiscal largess being promised from the Dems will likely dwarf prior levels, turbo-charging the nascent recovery just as it is getting going on its own. The Fed promise of cheap credit, combined with their 'turning a blind eye' to inflation further exacerbates the effect of this spending. The economic downturn last year was an anomalous episode in economic history and the recovery this time will be swift as the financial damage has been minimal. The sharp decline in consumer spending has not been associated with credit stress. The lack of tight money as a catalyst for the slowdown is something unseen since WW II or the Spanish Flu epidemic. This explains why the market is so confident in the 'over the horizon' recovery. Consumers are starting with a flush bank account and the Fed is bathing the banking system with excess reserves. Bank of America just reported a CET1 ratio that is usually achieved after a prolonged economic expansion. Easy money is back and the pump is already primed.

So when we actually get across this valley, what is the landscape like over the horizon? Nobody can say with certainty, but I don't think it will justify interest rates anywhere near current levels.

The supply shortages that have resulted from a curtailed supply chain, coupled with a pent-up consumer, will cause price-gouging behaviour of the likes not seen since the late '70s. I'm already locking-in my Florida rental for 2022 before they jack the rent.

Investor angst is also likely from two other sources as the recovery unfolds. Like many others, I worry that growth-sapping regulation and taxation will replace the brick in the wall-of-worry previously supplied by the pandemic. Already a whiff of protectionism has been wafting around the Biden executive wing, as the cancellation of Keystone and 'Buy American' are being posited as urgent policy imperatives. Although likely to be back-burnered until the economy is humming, tax hikes for the upper class are almost a sure bet. The Treasury will continue to pump out deficits and there is only one place they can turn to for the cash. The wealth that has been "created" by a rising stock market is a tempting target for the new policymakers. Eventually, the light bulb will go off over the heads of Janet Yellen, a person eager to cement her already redoubtable legacy. Now unencumbered by the hidebound traditions of central banking traditions, she is likely to willingly finance the profligate Democratic agenda through tax policy.

Gives new meaning to the phrase "when they're Yellen, you should be sellin'".

Yield to Temptation

I'm showing an updated yield curve chart from a prior blog. Each arrow depicts the path of interest rates in the post-recession. The 'return to normal' that everyone seems to be expecting is what worries me. There is at least another 100 basis points to go before the yield curve is anywhere near normal. Are we expected to believe this can be absorbed by a priced-for-perfection market? The consensus case for this year is admittedly for a steepening, as reported in the BofA survey this morning. But the 10 yr terminal rate from Wall St yield forecasters, according to WSJ, is a modest 1.44%. That rate alone would cool the market off, given current pe multiples in the thirties. What if the bond market gets trashed by a combination of excess supply and inflationary pressure? A rally-killing rate of 3% later this year would not be unprecedented, judging by prior episodes.

U.S. Treasury Yield Curve: 10Y/2Y

The interplay between the economic deterioration from a tragic second wave in the pandemic and the rose-coloured expectations of a better 2021 has set us up for a serious correction in the second half of the year. For now, bad news is good news, as investors have their cake (low rates) and are eating it too (earnings expansion). Trading the rally is going to be progressively trickier, with cross-currents of positive re-opening news, battling with higher real rates. Likely early casualties are the crowded mega-cap tech/consumer discretionary stocks. Hard asset stocks and Bitcoin are ahead of themselves and vulnerable should a rapid rise in nominal rates challenge the currently popular wisdom of currency debasement. A U.S dollar rally would set the cat amongst the pigeons in crypto. The Euro and Cad$ look like shorts here too.

Value stocks are still a compelling trade. The steeper yield curve is a tailwind now and the recovery narrative for market expectations plays right into their hands. Financials are the soft-cyclical 'lead dogs' in the economic sled race as we head off into the 2022 recovery. Investor dalliance with high multiple growth stocks stemming from the scarcity of growth last year seems likely to mean-revert in a rising discount environment.

Last year's winners are unlikely to hold up for more than just valuation reasons, not the least of which is the 'restart' economy's pivot back to in-person commerce. I don't know about you but I'm getting a bit sick of Zoom calls. They are the 'nothing burger' of this cycle. Zoom stock looks sick here as the rotation trade is starting to siphon capital from last year's popular shut-down plays. As well, the new administration's attacks on data privacy issues and heavy-handed anti-trust issues seem likely to trip up a few high-flying social media stocks, further cementing the case for the rotation trade. Also, I expect millions of used Pelotons to start to flood Kijiji by the spring.

There's a bit of a 'revenge of the nerds' feel here this morning with TSLA underperforming GM. If the real economy starts to kick in the virtual economy winners will continue to struggle this year. I see hedge fund style long/short trades outperforming this year. Hey, doesn't Volkswagon have a credible EV strategy too?

Risk Model: 3/5 -Risk On

Fundamental indicators of Volatility, Sentiment and Cu/Au are staying strong while the sideways tape corrects the overbought price variables. Impressive action, given the palpable froth evident from anecdotal evidence of over-exuberance in the SPAC and Bitcoin segments of the markets.

The shiny coin trick (look over here!) of this market is the investor's unshakable conviction in wonderous post-Covid reality now being promised by the ramping up of various vaccines.

It follows then, that until that narrative is replaced, this market will stay 'bid'.