Flash of Brilliance

Now that the consensus has moved to where I have been, I suddenly feel better. The recent purge in overheated growth stocks, which actually began last fall, had a feeling of capitulation about it. The bright flash you saw last week was the light bulb going off above everyone's heads.

The hallmark of bull market corrections is that they are short and sharp. Check and Check. This correction has been relatively mild, courtesy of the magic of rotation. If you were short bonds, long banks like you should have been, you actually made money last week. Yesterday the market averages were held back by the big tech stocks, but most stocks were actually higher. So the narrative change, from last year's infatuation with growth stocks to this year's cyclical/inflation trade, is complete. Everybody has seen the light.

What created this sudden 'ah ha' moment was the previously anchored expectations around bond yields abruptly and dramatically shifted. 'Anchoring' is behavioural economics jargon for the act of driving in the rearview mirror when it comes to investing. If you have gleaned anything from my blog, you will recognize this is the key to predicting market moves. Investors had been grossly underestimating the risks of rising bond yields. Wake up! Rates will continue to rise and will continue to hurt valuations.

Now that we have gotten that out of the way, the 'stock market' is looking more and more like a market of stocks. The correlation break we have just seen clearly shows us the new way to approach the market. Unfortunately many were on the wrong side of the trade recently. This is especially true for index-based passive investing. The bleed-through of mega-cap growth stocks to the broad averages is a natural outcome of their cap-weighted methodology. Most 'conservative' investors were underweight growth but hedged themselves by holding Apple, a stock with a large weighting that has done nothing for 6 months. You know it's a strange market when both Warren Buffet and Cathy Wood underperform.

Now that the narrative of rising rates and better than anticipated growth is rapidly being priced-in, it will, by definition, become the 'anchored' expectations for the year ahead. I fear that this will lead to a front-end loaded market that chokes on its own success. I have been of the view that markets could absorb the move to 1.50% yields. Now that has happened I'm getting ready for the next move. Fiscal stimulus is being heaped on extraordinary monetary easing, just when vaccines are knock out the last props of economic hesitancy. I think I see where this is leading.

Does anyone believe the Fed isn't behind the curve now? All that is holding up the market now is the anchored views of central bankers. Their views have been shaped by the post-GFC slow growth disinflation period that we have just been through. They are fighting the last war. But they are willing to stay anchored for now, and that will prolong the rally.

Let's assume that, for now, we rally to new highs on a short-term reprieve from an oversold bond market bounce. Then what? The key to timing the next correction market I believe won't come from watching the 10yr area. Expectations for ever-rising 10yr yields are getting priced in as we speak. A move to 2% or even 3% in the long end, following a pause here, won't really surprise me. Meanwhile, at the front end of the curve, rates have barely budged. That's where the Fed has been distorting the market most. Does anybody think that 20 bps is a reasonable level for short-term rates in a 6% real GDP world? We were at 1.75% before the Pandemic. The next light bulb to go off will inevitably be above Jerome Powell's head.

Watch this chart carefully. If it was a stock, you'd buy it.

U.S. Treasury 2yr Yield

So it is left to nimble, experienced investors to navigate the rocky shoals of this long-in-the-tooth bull market run. I have talked about the prowess of active managers in handling these types of investment environments. They have been long-suffering victims of the big cap bubble. No longer. My former partner at Aurion, Greg Taylor, is putting up spectacular numbers. Active PMs are loving this market now. It's their time to shine. Like a light bulb.

Risk Model: 4/5 - Risk On

Back into buy mode this week as the volatility measure, VXV, has calmed down. The Copper market is correcting after the recent spectacular run, and conversely Gold is catching a bit of a bid after recent repositioning by spec longs. This seems to be a countertrend move after the huge relative swing in favour of copper. I'm watching for a re-entry point for copper. The downshift in the imports of industrial metals in China has my attention though and their stock market is getting weak. The speculative fervour that has overtaken copper still has me a bit cautious. My view on oil above the $50-$60 range is similar.

Markets continue to levitate at or above 10% above the 200-day moving average - not a level that is comfortable. Sometime this year we should revisit the 200-day line, as even in bull markets, stocks usually test that level each year. Below is the chart of the XIU relative to the 200-day average with the blue line set at '0'. That would be a level at which I would become more aggressive on risk assets.

TSX ETF - XIU