Lapping the Field

In every race, there are always laggards. Some have experienced injuries. Some are just not up to the calibre of the leaders. Perhaps they are just having a bad day. They are often lapped, quickly forgotten, dismissed as also-rans.

The economic data currently being reported is like that.

A sense of calm descended on the markets in advance of the upcoming series of inflation prints that will be simultaneously hot, and transitory. This morning's strong March CPI will go down as the most widely discussed, but instantly irrelevant number of the year. Back in December, it was a good bet to predict a surprisingly strong inflationary environment as we lap the weakness of last year's data. It was equally a good bet to position for a rotation into the obvious beneficiaries, such as commodities and cyclicals. That trade has played out quickly, but and is now fading badly. The inflation scare is over.

Playing the value/growth rotation has been the alpha generator of the year so far. The ETF ratio I watch for this is shown below - using the Russell indicies. It shows significant out-performance of value stocks since the November Covid vaccine approvals. But some of that out-performance is now being lost. The backward check-mark is still intact, but the shape of this curve going forward is anything but obvious.

Russell ETFs : Value/Growth

I'm not arguing for a return to last year's market and it's binary growth/value performance. It will be a struggle to 'beat' the market this year. The economy still could out-perform the market after all is said and done. Equally, its hard to give up on the reflation trade so soon. We are about to get bombarded by coincident indicators that will seemly argue for an economic boom. Sticker shock is everywhere. Lumber prices over $1,000/mbf , Gasoline up 75% off their lows, $60,000 Bitcoin. Nobody was more bullish on copper than me, but anything over $4/lb is looking increasingly overdone. Oil has run its course as well as expectations are being reined in at the $60/bbl level. But we know most of this data is artificially inflated by the 'lapping' effect.

More to the point, the rate of change has peaked, from both the price signals coming from the commodities market as well as for inflation expectations. That means the second derivative is at work in shaping the leadership for market performance. If this market is to move higher, it will mostly be on the back of steady growth as the economy staggers back to its feet. Additionally, strong earnings reports from the value segments should also get renewed investor's attention as the forecasts are revised higher. Hence my call for a market of stocks, as opposed to a stock market. It's the "8-year-old's-soccer-game market", as I quipped last week.

Investors are now as exuberant as they have been for many years, but with good reason. The AAII survey, a population dominated mostly by elderly retail investors, showed us the highest level of optimism in three years. Of, course they are bullish - they're the ones getting the vaccine first! I have to admit being literally giddy when my wife and I received our jabs last week. An enormous sense of relief came over me. If you asked me what I thought of the stock market, I'd be optimistic too.

AAII Bull/Bear Ratio

The exuberance shown above is usually followed, not by a contrarian collapse, but by a plateauing of price momentum. The well-placed confidence investors are showing has been validated yet again by the calm reaction to this morning's well-telegraphed 'positive-surprise' CPI. This is not the market a lot of people were expecting - or hoping for. There have been many calls for pull-back that have gone unheeded by the market gods - and some made by retired PMs! But the combination of strong earnings expectations with a bond market that has failed to become a disorderly rout, means a sideways tape, with only 'mini rotations' to trade.

The race we are running has many laps yet to go. The next challenge will be a reassessment of the growth rates forecast for 2022. The key determinants of those will be global herd immunity (or lack thereof) and the fiscal and monetary backdrop going forward. Markets are not concerned with those factors yet. The May-June period is one of positive seasonality historically. I think we can melt up a bit more on earnings excitement before we need to worry about getting lapped later this year by the strength of the November rebound.

It's just hard to lap someone when the finish line keeps getting pushed out.

Risk Model: 3/5 - Risk On

Don't worry be happy! Nothing to see here. All my indicators are in a holding pattern - just like last week. Volatility is especially low considering all the headlines of a scary third wave. Unlike much of the world's population, markets seem to be complete immunity to Covid related news. No wonder wealth taxes have are being hotly (and justifiably) debated.

Cash on the sidelines is still building. Fund flows indicate a bit of rebalancing last week as the SPY was sold and the HYG was bought. A typical bout of profit-taking. The 'reopening' trade is pausing for breath. The crypto markets are warming up for a new bout of enthusiasm based on the Coinbase IPO (stimy cheques at work?). Spec positions in Copper have halved, but prices are just barely off the highs. Conversely, Gold specs are starting to rebuild after the vicious unwinding that started in January. Hmmm.

I see no fat pitch just yet. A consolidation period. That is a healthy thing though.