Hope & Awe

Democrats fight off the Red Wave.

Xi and Biden make nice.

Putin retreats in Kherson.

China's softens Covid Zero and backstops the property collapse.

Buffet bottom fishes Taiwan Semiconductor.

Walmart beats.

If wasn't for good news, there'd be no news at all.

Shock has been replaced with hope, leaving us with a sense of awe at the resilience of the market. The nexus of the bullishness remains the break in the U.S. dollar. Like a pressure valve, the bear market blew off the remainder of its steam in September and the crowded trades of the year have begun to unwind. That is bullish but does it mean a bull market has begun? Could be. Or not.

As they say on SportsCenter, let's go to the tape. But we need to go waaaay back for this.

In the last inflation dust-up, the 1978-82 era, the market experienced a monster 'jumping of the gun' as Chair Volker was fooled into believing he had won the battle too early. After moving policy rates to nose-bleed levels, the economy entered a recession, and rates headed lower. Unfortunately, inflation psychology didn't. Volker was forced to finish the job and administered rates were again jacked higher, causing a 16-month recession with a 10%+ unemployment rate.

Fed Policy Rates 1960-2000

The latest 'Fed pivot' hope rally that snapped this market to life has been sparked by the mother of all second derivative reactions to a slightly lower CPI inflation print last Thursday. The best saying I can recall about this is one of my favourite behavioural insights: "the market does the thing that makes the most people wrong". Obviously 'the most people' have been bearish this year.

In a year in which the vaunted 60/40 asset mix policy spectacularly failed to protect investors, one cannot be surprised by the depressed level of investor sentiment. I showed the AAII sentiment chart recently which showed an all-time low on a 30-wk moving average level. There's little debate about what has caused it given the news flow: Covid, the war in Ukraine, political polarization, and non-transitory inflation. Bull markets are born in pessimism, grow on skepticism, mature on optimism, and die on euphoria, as Sir John taught us.

I don't know if we are out of the woods (where the bears all live) but it sure feels like the market wants to stop going down. That doesn't mean it's clear sailing, but it also does mark a transition from the crowded trades based on the 'don't fight the Fed' mindset that dominated the first 9 months of the year.

Today's U.S. PPI print showed the first signs of deceleration in the rate of services inflation. That extends the 'bad news is good news' rally at least until mid-December. My working hypothesis of a market that does better than the economy is now coming fully into view. The next data point on which to focus is the non-farm payroll release on Dec 2. Given the lay-off news lately, it should provide additional impetus for the now more realistic 'Fed pivot' inflection point, furthering the risk-on mindset.

For the skeptics out there, there is still a small matter of the steeply inverted yield curve. Inversions often work through the system to unroot the problematic overleveraged business in the economy hence the FTX vaporization last week. Its CEO Sam Bankman-Fried is the naked swimmer I talked about last week.

There may be more.

This does call into question the premise of the soft landing scenario. The 'bid' to longer-dated Treasury Market securities implies a recession is in the cards, one that isn't being contemplated by the rising stock prices. Somebody's going to be wrong but it may take more time to sus that out.

For now, the data are headed in the right direction regarding risk assets and stock bulls are mounting a credible counter-attack. This year-end rally is nice but that's what happened in 1981. Should the inflation scare that is now abating reemerge, the Fed will be faced with the prospect of stepping harder on the brakes. I'm hoping that we don't repeat that dismal chapter of market history. At this point in the cycle, hope and awe may be our only strategy.

Risk Model: 4/5 - Risk On

The model has spoken. People have been so conditioned to losing money this year, they can't believe a rally that has caught them (me) napping. But the fund flows indicate there is buying going on. People are deploying cash, despite their caution. I get the sense from people that they are sick to death of more than just Trump. They want to get back in the game. It's a case of more buyers than sellers now - My new catch phrase is - "don't fight the fed-up!"

Copper/Gold

China has righted the ship for now and that has been reflected in the upside breakout in the Cu/Au model. They will need some continued good news on the Covid front for this to continue. The U.S. dollar seems to be helping both metals but the leverage goes to Copper for now.