Late Stage

As I write my message this morning, I also have one eye on the Giro d'Italia cycling race. Ever since I started riding myself, I have become hooked on streaming coverage of the sport of cycling. I love watching the riders travel through the ever-changing countryside in the various 'stage' races. This morning's start was delayed, and the race was shortened because the weather in Italy was particularly bad.

This isn't the only late stage I've seen today.

Stock markets are a monetary phenomenon. Earnings and the corresponding multiple awarded to them are all that matter in the final analysis. Monetary policy changes dictate both by creating "the cycle." The prototypical economic cycle has defined characteristics that often align with stock market action. When the monetary mavens at the Federal Reserve make policy changes, they dictate these different stages (see above).

After a recession, the "early stage' companies usually lead when the Fed reverses the tight money of the prior cycle. They include consumer cyclicals and financials as they experience an oversold bounce off the recessionary earnings decline. With its neutral Fed stance, the mid-cycle environment usually has broad participation. as the maturing economic recovery proceeds. Late cycle characteristics will see a hawkish Fed fighting inflation that prompts deep cyclicals and hard asset plays to dominate. Hence the old expression I found myself using: "Every bull market has a copper roof"

Has anybody noticed the copper market lately?

But making a case for a recession has been a Sisyphean task this cycle. Calls for a hard landing have been present since the Fed began its monetary tightening over 18 months ago. Today's news of Michael Wilson of Morgan Stanley's capitulation shows just what this market's ever-higher grinding pain trade can do to the left-for-dead bears. His note this morning isn't so much a reversal of his negative view as it is an admission that the confusing persistence of this bull market is unforecastable.

I beg to differ. I'm forecasting a harder landing than the market thinks.

What has confounded the many bearish implications of a 500 basis point hike in administered rates and the consequent inverted yield curve has been well documented. Structurally rigid labour markets, locked-in 30-Yr mortgages, distorting supply shocks, and excessive fiscal stimulus are all largely to blame. Layer on top a good dose of momentum mania over a 'theme' represented by Artificial Intelligence, and you will get a rip-roaring bull market. But, as I have often pointed out, the participation from the average stock is lagging. For that to change, we will need enough weakness to create a true 'restart' from the Fed. For that, we still need a recession that is currently unanticipated.

I still contend there is too much money chasing too few stocks. A few quality growth stocks gather all the attention in a scarce growth environment. Tomorrow's Nvidia earnings release has demonstrated that. However, the market's reaction to these numbers will be instructive. I'm watching carefully for a 'sell the news' reaction that would indicate an exhaustion of buying in this crowded trade. A volume non-confirmation has occurred on this latest rally, and a double-top formation is forming.

NVDIA

Although delayed by extraordinary events, monetary contraction is slowly working toward final demand and employment. A recession delayed is not a recession denied. A slow-motion slump in output and employment looks to be inevitable now.

The tailwinds from low levels of corporate debt and cheap labour have kept earnings from a more pronounced shortfall so far. Easy financial conditions have resulted from a Fed that keeps hinting that "rate relief is coming"! Cheerleading the widely accepted 'soft landing' narrative seems to be a feature, not a bug, of Fed-speak. The market has fully subscribed to this cheery outcome despite the risks. It's expensive and over-loved. Any upside from here is asking for trouble.

You can count me a full contrarian bear now that one of the last remaining ones has capitulated.

Sell this late-stage market!

P.S.

I would be remiss if I didn't award huge credit to one of my favorite market strategists, John Aitkens of TD Cowen, for helping reinforce this bearish call. His careful dissection of reams of sometimes arcane economic and market data has been invaluable over both my previous active career and now my self-indulgent blog posts. He may be the most underrated analyst I have ever had the pleasure to counting as counsel. I wish him as enjoyable a retirement as I have been privileged to have.

Thanks, John.

Risk Model: 3/5 - Risk On

The AAII BULL/BEAR ratio has come agonizingly close to generating a plus signal this week. The heading, 'a market can stay irrational longer than you can stay solvent', keeps me watching from the sidelines and not short this market just yet. The chart below has stripped out the daily measures and presents a smoothed 30-week moving average. If one considers this an oscillator of sentiment, you might want to raise some cash into any strength. Too many bulls for my liking now.

AAII BULL/BEAR Ratio - 30 wk ma