Memory Lane

It's 1994.

Jeff Bezos founds Amazon. China connects to the internet. Newt Gingrich leads the Republican Party to victory in the U.S. Congressional mid-term elections. An Original 6 team ends a 54-year drought to win the Stanley Cup.

In the Financial Markets, the bond markets are rocked by a surprisingly hawkish Federal Reserve after they hike rates, removing the stimulus provided during a severe recession two years prior. Interest rates rise throughout the year and stock prices chop sideways as valuations compress, but earnings rise.

The economy continues to do better than the stock market until signs of a slowing economy are sufficient to allow a rally in both bonds. The equity bull market resumes after a choppy trading range year. Bullishness soars after a tough transition to a higher rate regime.

Measures of market sentiment - CBOE Implied Volatility and AAII Bulls - were at extremes, spiking early in the year and again nearer to the election. After the elections, Democrats hold the White House and the GOP controls the Congress.

It all fits. This is as good as it gets when it comes to a forecast for the current environment. Don't shoot me if it gets a lot worse. Maybe the 'soft landing' scenario is too Pollyanna for you, but I still kinda like its chances. No one believed it in '94 either.

Jes' sayin'.

Risk Model: 4/5 - Risk On

Markets seem to be holding up well in the face of an extremely negative sentiment backdrop. Last week saw a huge amount of ETF outflows, and the markets bent but didn't break. I am struck by the divergence between the AAII Sentiment indicator and the CBOE Volatility Index. Just as we saw in the months after the onset of Covid in 2020, the two measures of sentiment have recently diverged (chart below). The AAII is a measure of individual investors and is a longer time frame, 6 months vs 3 months for the VIX.

I view AAII as a look into the mindset of individuals, mostly older retired guys who play the markets for fun (if the shoe fits, Deck!). The CBOE is an amalgam of speculators, both large and small, managed money, and 'commercials' such as the big Wall St banks. This divergence doesn't surprise me. I still believe a trading range, similar to that seen in 1994 is the model for this year. We may have already seen both the highs and lows of the year.