Jackson Holeshot

In auto racing, getting out to a strong shot confers a huge advantage over the field. It's known as the 'holeshot'. Given the high speeds and with only a few opportunities to pass, a good start is often all that is needed to win the race. Getting off the line quickly is critical.

The market seems to have taken this approach in the race to year-end that seems to have started last week. They have made up their minds that Fed Chair Jay Powell's unveiling his plan to taper bond purchases are both inevitable and survivable. All that's left is for him to say the words in his speech this week. And the markets don't seem to care that the removal of monetary support is usually accompanied by increased volatility. In July, I described this as the 'tanks at the border' pause in market momentum in advance of a highly anticipated event. Little did I know that the airlift in Afghanistan would coincide with the lift in the market, but so it goes.

What people are anticipating is an environment of benign and stress-free transition to the next phase of market dynamics as we re-accelerate out of the fourth wave slowdown that has created an internal correction in the markets. Consensus was for this correction to be widespread. I said as much last week as a weak market started to develop ahead of Powell's speech this week at the virtual Jackson Hole Conference. Wrong again, major correction camp! We have been looking for a dip, not realizing that one has already occurred. What I stated in my July 20th piece, "Buy the Dip" still applies...

"I believe the next phase of the reopening trade will start to develop over the next few weeks. The 2022 growth rate, although notionally lower than the base effect distorted 2021 levels, will be highly attractive for cyclical stocks. The technical sell-off in value stocks we have experienced is now setting us up for the next phase of the bull market."

I see a golden opportunity to re-enter the cyclical/value trade after the Q3 pullback.

The dip, in relative terms, was fairly substantial (chart below). The return to the consensus trade of higher yields and stronger growth is shaping up nicely after being derailed by the stubbornly persistent pandemic. Now that the peak levels of Delta variant are being seen, I anticipate that investors will soon begin to expect an economic re-acceleration into 2022.

It will be hard to catch the current leaders in the race to year-end honours. The likes of GOOGL, MSFT, and AAPL will likely end the year as the market leaders. It's what comes after that counts. Today's supply constraints will create a catch-up phase for an inventory cycle that will dwarf prior cycles. As the debilitating pandemic turns into a manageable endemic, economic activity will continue to accelerate.

The re-rotation trade is the way to play it. Financials and economically sensitive value stocks are about to reassert their leadership as we head into the third year, mid-cycle phase of the bull.

It helps that we are starting from a level of monetary accommodation of generational largess. Today's Fed is totally committed to staying behind the curve, if for no other reason to redress the wealth gap. This socially laudable but economically risky policy shift will ultimately create financial stress cracks in the already over-levered system. But for now, we will benefit from the loose policy of 'too much money chasing too few investment opportunities that has generated the current asset bubble. Remember, it took years for inflationary expectations to become embedded the last time this policy was tried in the 'Stagflation '70s'. And it took even longer for the Fed to summon the will to do something about it. We will have time to play this trade well into the current decade.

Even though the seasonal weakness for equities has yet to be fully dealt with, it would be prudent to start to build your 2022 portfolio now. Despite the big advantage built up by the market leaders, it is a long way to the finish line, in my view.

Risk Model: 2/5 - Risk Off

A weak sentiment reading from AAII is a co-incident indicator in my view. It could rapidly flip into a bullish reading now that volatility has subsided and the taper tantrum 2.0 theory becomes further debased by a grudging acceptance of the possibility for rising stocks and rising rates. Now that China is reversing the monetary tightening of earlier this year, the commodity cycle can look forward to a resumption upward bias following the recent sharp pullback. For now, we await a buy signal from the model that may have already lagged the resumption of the bull market.