Crunch Time

Buying into this market now is like skipping the first three quarters of a basketball game, and then tuning-in for the last 12 minutes. But usually, that's when it gets exciting. The teams tend to shorten the bench, playing only their best. The last-second playbook is often designed to get the ball into the hands of the star player for that one last shot at glory.

Value stocks, the 'bench players' of this market, have recently gotten some minutes. Vaccine re-opening hopes, coupled with a post-Trump feel-good, supported expectations of a seamless economic re-start. That all changed last week with the sober second thoughts around the decelerating economy and the worsening pandemic outlook. "No matter" said the bulls - all we need to do is switch out the second squad for the superstars who have been resting on the bench since October. With Netflix as the point guard bringing the ball up-court, all the 'first squad' stocks got in on the action. In a flurry of re-rotation, the growth stocks went on the offence.

How long this game lasts is anyone's guess. Ominously, this interplay of the pandemic with the financial markets is starting to create a decline in breadth and correlation. Last week's decline in financials, energy and old tech sapped much of the market's health. Fewer stocks are making new highs. The percent of stocks above their 50 dma has peaked (below). The momentum players are running out of time as fewer trades are now 'working'.

% Stocks Above 50 DMA

The lack of breadth is evident in a very low correlation for stocks in the S&P 500. Prior periods of low correlation have often preceded corrective phases. Just as in the last minutes of an NBA game, fewer stocks are carrying the ball.

Correlation - S&P 500

I'm waiting for a change in this narrative before getting more aggressive on the market. A renewed flattening of the virus curve is likely to occur by the second quarter. Vaccines, after this initial hiccup-prone phase is supplanted by a more efficient process, will become widely available then. Will investors have a new game to bet on? Can we get there without some pain?

I'm looking for the end of this 'have your cake and eat it too' phase. Increased earnings and low rates that have driven markets so far this cycle is not a sustainable strategy. I expect people to start to price in a period of declining multiples, which will offset rising earnings. The real economy will start to compete for the liquidity that has built up in the system. Rising real rates and weak stocks usually go together.

It is of no use trying to call the exact short term peak in this market. I think of this more as a process of topping-out than of a bubble that bursts. Choppy and volatile ranges should begin to replace the 'V' shaped markets we have seen. Rotations from past winners to laggards and back again is typical action in the final stages of an intermediate market cycle. Playing these swings is a mug's game and I won't get caught up in it.

As for the 'speculation' phase in market psychology, I think we can safely say it is here. When the

options market can be used as a' gameable lottery' by Redditors ganging up on short-sellers, we have come full-circle from the dark days of last March's COVID 19 induced panic.

My argument, that many followers of my blog will recall, is as follows: as the curve of infections flattens, the curve of yields will steepen. Rates should eventually rise and choke off the equity rally. So being prudent, I am waiting for that narrative to develop with cash ready to deploy. Last week's bad news on the pace of vaccine roll-out was good news for investors who feel the current monetary policy largess has got their back.

The game that started last year seems to be headed for overtime.

Risk Model: 4/5 - Risk On

The more things change the more they stay the same. This period of stasis in the indicators would argue for staying the course as the overbought condition works itself off in a sideways choppy market. With the Canadian and U.S. stock averages more than 10% and 16% above their 200 day moving averages respectively, the wait might be a long one.

Seasonal weakness that often accompanies early February is a distinct possibility this year given the stretched market conditions. Watch Chair Powell closely for any sign of discomfort with the speculation in markets and any commentary on financial conditions. The code word Greenspan used was 'irrational exuberance'. Powell has to come up with his own. I suggest "Reddit Flag".