Hockey Fight

In a surprise move, CN Rail has pulled the jersey over CP's head, entering the fight for Kansas City Southern Railway. It's a risky move, given the possible threat of a third-man-in penalty that might be invoked by the market, but they know what they are doing. Control of the continental rail markets is at stake, and it's a prize worth fighting for - however politely. How Canadian is that?

What this means for the greater markets is not entirely clear, but it does reaffirm one thing - the old economy isn't dead just yet. It also validates the old real estate chestnut, location, location, location. The good thing about railways is, once built they don't ever move. Asset plays don't just involve IP from Silicon Valley or the Blockchain NFTs. After the last few years of a singular infatuation with sexy growth stocks, this is the ultimate revenge of the economic Nerds.

Also in the news last week, Air Canada revealed the long-awaited bailout provided by the Canadian government. Effectively a railway in the sky, Air Canada is a very valuable asset despite this being the third bailout of the same asset in 30 years. Correctly this time, the Feds took an equity stake. I can remember a time when Ottawa had the chance to buy cheap stock and passed. They finally got this one right.

A reappraisal of value has now begun to reach the real economy. And well it should. These are scarce assets. Owning voting claims of scarce assets is at the core of equity investing. It's why I never own bonds. Ownership has a value beyond the DCF. The process of arbitraging the inflated value of intangible assets against the discounted value of real assets has begun in earnest. I mean if Dogecoin, literally a joke, can command a value of $50Bn, surely a railway that actually produces value can be re-rated.

This process is best left to the stock pickers. There a going to be winners and losers. I'm not in the business of providing that advice. But the type of stocks that can now provide upside has broadened out to include the old economy stocks. The excess liquidity being provided by the world's central banks has seen to that. Too much money chasing too few assets is still the operative mechanism here.

This is directly reflected in the strong breadth of the current market. If there is one warning sign common to an imminent bear market, it is falling breadth. Markets inevitably lose participants, as stock averages crest. The Fed has usually hiked rates and the more interest-sensitive segments of the market fall to the wayside. That causes market breadth to weaken. The failure of breadth to validate price moves in the broader market is the hallmark of market tops. So should we be worried this month? Let's go to the charts. I have depicted the last few episodes of market action before a major top with a red verticle line marking the "top" in the S&P 500 for the cycle.

S&P Breadth - 1996-2003

S&P Breadth - 2006-2009

S&P Breadth - 2017-2021

Unlike the last two major topping episodes, there is no deterioration in breadth evident in the current market. In fact, there was no evidence of deterioration prior to the sudden setback last March during the Covid 19 crash last year. The underlying health of Mr. Market prior to that downward swoon is instructive when considering the surprising strength since the lows of last year. He was a healthy specimen before the infection. No surprise that he has survived a brush with the virus extremely well and come roaring back.

As earnings season rolls on here. the markets seem to want to take a pause. Last week saw the lead dogs in the earnings release pack, the banks, reveal strong numbers, mostly due to underwriting of the SPAC mania. The Banks' tepid reaction to the sizeable earnings 'beats' seems related to a softer assessment of future loan origination. But there was no outsized reaction, just a sideways drift. The fact that the bond market has survived its inflationary scare didn't help bank sentiment either as the tailwind of wider net interest margins ebbed.

So let's just sit back and relax. A disorderly bond market or huge negative earnings revisions aside, there is nothing to see here. Any pullback would go a long way to helping dampen down some of the excesses being built up recently. Retail exuberance has taken off again this week with the Dogecoin bounce and the $100mm valuation for a New Jersey deli that got talked up in the Reddit chatrooms. 'Stimmy cheque' effect I'm guessing. That too shall pass. Unlike David Einhorn, I don't see this as evidence of a generalized market bubble. As long as the Fed has our back, the game is still on.

And now, thankfully, an old-time hockey fight has arrived to liven it up!

Risk Model: 3/5 - Risk On

How does an itchy trigger finger top-down guy like me spend his time while the model tells him to stay put? I spend a bit of chart time. The chart below validates my comments recently that the market is "porpoising". Each move higher has been followed but a temporary, shallow pullback. The most recent episode started last week, coincident with the start of earnings season. I'm hoping the volume indicator (Chaikin Money Flow -CMF) starts to shape up as it has been in a downtrend for 5 weeks. Money recently sidelined by the bond yield scare is likely to reverse that shortly.