Death Metal

No, this isn't a group of bond managers after their morning meeting. These are representatives of a nihilistic genre of heavy rock known as Death Metal. But our poor Bondies could pass for the same.

Short of a big rally this quarter, 2023 will mark the third consecutive year of absolute negative returns in the bond market. The brief rally in bond prices last week on the back of the Hamas attacks has faded this morning on news of Biden's trip to Israel and stronger-than-expected retail sales. Hence the resumption of the bond bear and its march to a 5% Ten Year bond yield.

Although better than feared, the current earnings from the U.S. banking sector are being met with a yawn from investors. Analyst commentary is focused on the two remaining negatives: recession risk and embedded losses on 'Held for Maturity' portfolios. Bank stocks are only slightly off their lows as these opposing forces battle for dominance in investors' minds. As the bond market extends its losses, banks get further underwater on their capital reserves which are composed of ostensibly low-risk long-dated bonds. The term 'low risk' is becoming a dangerously off-base misnomer.

But the real depressing market development over the seven days since my last message is the performance of the copper market. There is a growing fear of global weakness, centered in China and augmented by ex-U.S. growth slow-downs notably in Germany. This has combined with the typical seasonal weakness to keep copper markets in check. Gold has regained favour as a haven this week for eminently understandable reasons. Hence the collapse last week in the copper/gold ratio that was the topic-du-jour in last week's Tuesat11.

This begs the question - is copper really the death metal that it appears?

Copper/Gold

I don't believe that the full impacts of the recent rise in yields on long-dated financial instruments have had a chance to show up yet. Certainly not in today's Retail Sales numbers that reflect a period of rising real incomes, falling inflation, and reduced recession fears that prevailed six weeks ago. The fourth quarter should be a different story, especially as the December rate hike is now back on the table.

Over the past few weeks, I have been cautiously optimistic that the markets will find their lows in the next month or so. I talked about "hold your nose" bottom fishing in the banks. But I have also counseled a degree of 'show me' - especially when it comes to the best indicator I know; the Cu/Au Ratio. "Listen to the Doctor", I said. This week was not the diagnosis I have wanted to hear.

What we need - and fast - is a series of negative economic data that will, perversely help by turning the narrative towards an easing in monetary policy. Anecdotally, the U.S. consumer is running on fumes as higher mortgage rates have depressed demand for financing to 20-year lows. Housing is still the best generator of economic activity known to man, despite the service economy's rise to prominence.

Mortgage Rates, Applications Index

Any thought that businesses can cushion the blow is easily disabused by looking a a chart of disappearing loan demand at commercial banks. No wonder banks can't catch a better bid - their core business sucks.

Commercial & Industrial Loans

So far, investors have been sanguine about the possibility of economic declines that will affect them. As the bullish herd rumbles on with a preference for the narrowly-led stock market where is the hard landing gonna come from? Cue the 1987 comps! Bonds broke the stock market back then and could well do it again. I have shown below what that looked like. The economy was strong and inflation was rising. It was a valuation mismatch that broke the market. No biggie - just a small 25% one-month bear market was all that happened.

10yr Bond Yields, S&P 500 - 1987

10 Yr Bond Yields, S&P 500 - 2023

I don't know if the 1987 outcome is in the cards today, but I can't ignore the risks of a shrinking equity risk premium combined with a Federal Reserve that is fixated on trailing data for its decision-making. Until such time as there is sufficient evidence of a weakening consumer and falling output in the U.S. economy, we should be holding some rainy-day cash just in case the FOMC hikes again.

With copper prices softer this morning again, you'll have to head over to Spotify if you want some hard rock.

Risk Model - 2/5 - Risk Off

The sentiment readings are cautious, reflecting the sudden weakening of confidence after last week's horrific events in Israel. Absent an escalation, this is as bad as it should get. Biden's trip is a coin-toss moment as his leverage over the Netanyahu government may have been overstated by the optimistic spin doctors on Wall St. this morning.

The TSX is still stuck in a trading range and has regained a neutral reading for both the RSI and the 200 DMA tests.

XIU - TSX60 ETF

The leadership rotation that I depicted last week has failed to follow through as the Magnificent Seven accounted for most of yesterday's bounce. If there is a defined low in this market, I believe it will come from a final capitulation in the crowded Growth trade. It is especially vulnerable to rising rates, given the valuation premiums over the broad market and especially over Small Cap.

Note - when this relationship breaks it is sudden and violent.

Patience is a valuable skill to have now.

Growth/Value Ratio - ETFs