Market in Love

If you have been waiting for an entry point to get invested, I have bad news for you. You are not alone.

Cash is still a crowded trade. Just read the Bank of America Fund Manager Survey to see how the consensus has held firm to the bearish case. To quote the survey:

"About 66% of participants in the bank’s February survey said stocks are seeing a bear market rally — signaling they expect them to return to new lows. That’s even as the share of investors expecting a global recession fell to 24%, down from a peak of 77% in November."

The market loves to make the most people wrong. After this morning's data, and after a head-fake down opening, naturally, on Valentine's Day, it is in love today.

As we saw last week, the calls for a pull-back last week, predicated on a frothy market driven by short-covering and led by low quality, was hardly the 'buying opportunity' everyone has been looking for. Monday's bounce erased any chance of a cheap entry point and today is following through. There is still too much cash looking to re-risk for the markets to meaningfully retreat. But that's the problem. The bears, clutching tightly to their S&P 3200 targets, are squirming with every uptick. In the market staring contest, they seem about ready to blink.

The narrative driving the market is clear. The soft landing, immaculate disinflation scenario has replaced the traditional recession, credit cycle-driven bear markets of the recent past. As my previous missives have argued, the cashed-up, bearish investment consensus has been completely wrong about the immediacy of a recession. It still remains a possibility, but for now, the market can still dream.

Buoying the markets is the underinvested status of funds and individuals who were scared off by the inverted yield curve (Deck, I'm looking at you) and memories of past debacles, Dot-Com and GFC most notably among them. But the bulk of the damage to equity prices was already done by October last year, as a garden variety bear market of S&P down 22% and Nasdaq down 33% had unfolded, far in advance of any economic deterioration. Investors seemed to have jumped the gun by hunkering down too far in advance of the actual events that would justify that stance.

Markets love certainty. The recent data is therefore comforting, not because it's all good, but because it was highly anticipated, and even better than feared. Inflation is coming down, albeit in a choppy fashion, as this morning's CPI showed. Employment is hanging in there. And most importantly, early January retail sales data from MasterCard printed at a surprisingly strong 8.8%. The pain trade - higher - is still in control of the market.

This is not the market I want, but the market I see. Deal with it. My preferred scenario of an upward, choppy tape into the second quarter of this year still stands. A resurgence of inflation that leads to a renewed interest rate risk later this year is a story for later this year. Meanwhile, the Goldilocks soft landing is unfolding as we speak. Home buyers are back, with just a slight drop in mortgage rates. Car prices are again rising. Restaurants and planes are full again. Sorry, perma-bears, after calling for Armageddon you have instead called the bottom - but in reverse.

I see no rush to chase this rally, but shorting the market while the data remains supportive of the bullish case, seems fruitless. A narrative change - persistent inflation above expectations or weaker service employment - seems a long way off. But that will, at some point, present an unpriced risk to the love-in now unfolding in the stock markets. For now, market, I love you!

Risk Model: 5/5 - Risk On

If you want to see further evidence that expectations of an imminent recession have sharply diminished, look no further than last week's AAII Bull/Bear ratio (chart below). Emboldened by a seasonally strong employment report and reinforced with recency bias from rising stock prices, the survey showed a surprisingly sharp reversal from last year's pessimism. Given the high cash positions and equity allocation underweight in most portfolios, you can see why the bears are getting frustrated by the sudden appearance of these previously cautious market players. I did not see this coming so soon, but it is clear that the year-long bout of pessimism driven by the Fed's tightening campaign has reversed decisively. The bulls are back in charge of the tape - and the old saying is "don't fight the tape".

AAII Bull/Bear Ratio

The recession forecast from Dr. Copper is nowhere to be seen. This supports the bull case for a soft landing as well. It may be a China restart or the low copper inventories, but second-guessing the implications of this indicator could be dangerous.

Copper/Gold Ratio