Clear as Mud

As the BC road system washes into various creeks and rivers, people are suddenly being stranded and displaced, left wondering what's next. The raging swollen rivers viciously destroyed roads were never meant to handle the record rainfalls induced by rapidly warming oceans. Designing for a 100-year storm doesn't work when what you get is the 1000 year variety. Increasingly our daily activities are being affected by powerful forces that seem out of our control. Chalk up another victory for climate change against humankind's hubris. The future seems as cloudy as the rushing waters now coursing through the lower mainland.

These uncertainties parallel those facing investors, who have sharply divided viewpoints about the upcoming year and the prospects for capital market performance. The main camp, entrenched in the TINA/FOMO world of the past year, believes in a bullish sequentially smooth path to higher stock prices based on a full recovery to pre-Covid levels. The trend is the trend until it ceases to be the trend. Today's Bank of America investor survey reported record levels of optimism.

In camp 2, there is a small but growing group of people who are sceptical of such a pollyanna scenario. This latter cadre includes the usual cast of perma-bears and financial tinfoil hatters that have been glumly watching from the sidelines of one of the best bull market runs in history. But I am watching for signs of a new set of entrants - the contrarians.

They, like other sceptics, have been silenced by the sheer enormity of policy support (read easy money) from governments the world over. But not wanting to fight the Fed, they have reluctantly remained positively disposed to markets this year. The year started off as a straight-up cyclical recovery with higher global growth and higher rates as the consensus view. The Delta Variant threw that scenario out the window. But most investors pivoted back to growth stocks and continued to run with the bulls.

By mid-year, we again experienced a 'back to the future' rush into growth stocks promising everything from EV domination to Fintech nirvana. Meme traders grew rich at the expense of short sellers for no reason other than the fact they outnumbered them. Logic was thrown out the window many times during the frothy bull run punctuated by Tesla's successful ascent on the Mt Everest of the stock market - the Trillion dollar club. What a year it's been. No wonder the bears are in hiding.

Now, as we head to the finish line of a monster year for risk-taking, I dare you to now see more than six weeks ahead. Muddy waters lie ahead from many sources. The shortlist of recently surfaced worries isn't so short!

They include;

-Fed Chair reappointment politicization

-Debt Ceiling impasse

-China's real estate bust

-Waning vaccine efficacy and increasing break-throughs

-Vaccine mandate wars leading to social/labour unrest

-Persistent vs 'transitory' inflation

-Stubbornly flat yield curve and what it is saying

-Bullish overconfidence for risk assets

This list is likely to change. But what will not change is the increasing volatility of capital market behaviour in a global economy that has yet to 'normalize' - whatever that means. As the UK and the Eurozone continue their struggles to generate sustained growth, and China wobbles under the weight of a now-broken real-estate Ponzi scheme, the U.S. blithely motors ahead in a bullish melt-up rally of everything. But like the Coquihalla, I'm seeing a few cracks in the previously smooth roadway to 2022.

Valuation, often taken for granted, matters more than ever now that the free money era has been declared an endangered species. A tricky set of policy changes lie ahead for Chair Powell next year, any one of which could spook the bond market. The mega-cap growth stocks that have propelled this market on the back of low rates are at risk of PE compression. And their various offshoots like Cryptocurrencies, IPOs, and SPACs, risk fading from the radars of the now shrinking Robinhood crowd. They seem tired and picked over. One by one, we are seeing mini-melt-downs in previous darlings like Peloton, Facebook, Paypal, Moderna, and Disney. Even Elon Musk knew it was time to sell last week. How long before we see corrections in Microsoft and Google - the last men standing in mega-cap growth?

As we head into our 20th month since the NASDAQ last touched the 200-day moving average, I see no reason to continue to expect a repeat in the year ahead. In either scenario, continued expansion or a renewed slowdown, the market will correct and/or churn. I said, earlier this year, there is a risk that the economy does better than the stock market if growth accelerates from here. That scenario was deferred by the Delta/Covid slowdown this year but remains a risk. Should demand growth suddenly falter from an inflation-driven surge in rates, there is a substantial unpriced equity risk from such an unexpected growth scare.

Either way, the first phase of the easy money-driven market is likely to be replaced by a more challenging year ahead. And that is clear as the mud in a B.C. river.

Risk Model: 2/5 - Risk Off

With the RSI above 70 and trading 11% above the 200 dma, the XIU seems like a bad bet right now. Oils and Materials stocks have seemingly crested, as Financials also take a pause. So far, all we have seen is a 'time correction' working off the overbought condition without a catalyst to pull back. Frustrating!

Gold is also pausing looking for direction after a sudden spurt but I still like the hedging characteristics of "Boomer Bitcoin" here. Copper has pulled back, succumbing to a concerted effort to replenish the ME warehouse stocks that drove it into backwardation. I flagged the risk of a correction of the short-squeeze rally a few weeks back and that I didn't trust the artificial copper move in October.

I have bigger concerns for the year ahead. Copper has been a go-to commodity for the EV bulls dreaming of an electrified future. The same crowd was short oil as an expression of their distaste for fossil fuels. It hasn't gone so well, as energy is the best performing group this year despite the pension fund position blow-outs. As China goes - so goes copper, as we head into 2022 and supply is set to rise sharply. Dr. Copper is prescribing caution.

AAII sentiment is stretched but supportive of markets for now. The VXV is subdued, reflecting the lack of tension from the recent good news environment on earnings and continued Fed dovishness. That could change quickly so, like gold, some UVXY may be a good hedge.

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