Last Man Standing

Just as everybody has a plan until they get punched in the face, everybody is a bull until they lose money.

Last week, my call for a double top in Nvidia and sell-on-news was a punch in the face. Admittedly, the forecast was more of a guess than any insight. I sheepishly admit that the call to sell this news has been a spectacular 'own goal' as it soared to new highs. But I stand by my market call. And the market responded poorly to the NVDA news. An "outside reversal day" is a bad sign for the S&P.

With diminishing tailwinds, the economy has been weakening slightly this year, but that does not affect a company like NVDA. Artificial Intelligence adoption is in its early stages and there is little the Fed can do to stop it with tight monetary policy. The stock market's growth-oriented segments can keep diverging from the economy as long they reflect an innovation-driven event that promises better earnings through productivity enhancements.

That is all good for the narrowly defined "market" dominated by the megacaps. But even within the Magnificent Seven over the past week, only one stock was up significantly—Nividia. The rest of the market, which reflects more economically sensitive segments, broke down. Real Estate, Banking, Retail, and Energy all have lagged behind the move by the NVDA-fuelled rally. The equal-weighted index is trading at 10-year lows in relative terms.

The news is also not good for the Transport Index, a bellwether sector for economic performance. The group is at a low point and is dangerously close to failing, especially since the goods side of the economy has endured the brunt of the Fed's rate hiking effects. The Service side of the economy is holding up but still dominates the positive economic data now. The linkage, although weaker than historically seen, is still valid.

So why is everybody bullish? The latest AAII Bull/Bear Readings show optimism normally associated with an expanding economy and a broadening market. In the old days ( during my career?), most people bragged about the stocks they owned. Market tops were rife with people talking about IBM, Nortel, or even Bre-X. Not so in the era of passive funds and ETFs. The "market" is all they seem to care about.

Last week, retail market participants were fooled into believing that "the market" was still rising, with the NVDA hype drowning out all other news. There has been no change in sentiment as the props are pulled from underneath the stock market one by one. In the seven months since the October '23 "Dimon Bottom," we have come a bit too far. We are vulnerable to either interest rate or earnings disappointments that should dampen the animal spirits somewhat.

And we have a dovish-biased Fed to thank for that. How else does one explain their incongruous depiction of the monetary conditions as 'tight' with evidence from their own data of low levels of easiness in financial conditions? How can we expect such an easy money policy to translate into sustained lower inflation when the evidence from the 1970s is there for all to see? Is it behavioral anchoring at work here? Are 5% rates high or low? And now there is a consequential risk of rate hikes to combat renewed inflation later this year due to this stealth easing policy of the Fed. Rates may not be as high as you think.

Good news will soon be bad news for the majority of stocks. The Fed is now behind the curve that bottomed out in Q2. As the data continue to rebound from the initial shock of last year's hikes, it depicts a less bad-than-expected but still sluggish economy with a rebounding inflation signal. That should take the last remaining rate cut off the table for the year and sour the now-ebullient sentiment. The U.S. election cycle will heighten the sell-off as the low-volatility mirage fades into history.

As we approach the Fall, the deterioration in stock performance will be like the punch in the face that changes everyone's bullish plans. Brace yourselves.

Risk Model - 5/5 - Risk On

So why am I saying 'sell' if the model I developed is so bullish? 5/5 is not the best reading for expected returns. It has a lower hit rate for positive returns than 3/4 and 4/5 and is more short-term oriented in its signaling. It doesn't capture the surprise factor at inflection points. Remember that it was also late for the party last October. I like to use it when trending markets have defined patterns. I dismiss it at my peril, but if I'm wrong, I'll take that punch too.

Dr Copper got smacked pretty hard last week. This isn't unusual after breaking a trend line. A sharp pull-back due to profit-taking is all that I expect unless Jerome Powell suddenly turns into Paul Volker. Yeah, and I'm Mike Tyson.