Mixed Signals

Everything Elon Musk touches seems to turn to Bitcoin (I used to say gold, but after last week's move in the crypto market...). His offhand comment to "use Signal" sent the shares of a previously unknown company, Signal Advance, soaring last Friday, as frenzied day traders jumped on the momentum train. Armed with only the knowledge of the stock symbol, SIGL, rabid speculation moved the stock rapidly higher from mere pennies at $10. Impressive. Except he was referring to the encryption-based messaging service named 'Signal' - not the tiny medical device start-up with little revenue and one employee. The most surprised guy is the company CEO, who promptly put out a warning to investors in a vain effort to clear up the confusion.

So why, after the dust settled on Friday, and after the revelation that Musk's comment was taken completely out of context, did the stock soar to almost $70 and close yesterday at $38.70? Ahh, dear reader, this is what I love about the stock market. The answer is simple; there were more buyers than sellers. Now you know why the market is not rational and behavioural elements often dominate in the short run. Momentum based algorithms? Johnny-come-latelies? WhatsApp chat line hype. Who knows?

I have said before and I'll say it again "don't confuse a bull market with brains"

The backdrop, courtesy of our friends at the Fed, is that there is too much money chasing too few things. This is the hardest part for people to get their collective heads around in bull markets. The 'Narratives' (read Robert Schiller's book) that drive markets have fertile ground on which to grow.

A case in point is the run-up in cryptocurrencies. The use case for crypto-coins rests currently on the debasement of fiat currencies by profligate governments. That part I get, but what about the primary role of a currency as a medium of exchange? How can I be comfortable using Bitcoin to pay for my pizza if the coins I fork over could be worth more than the guy's business in a month? And as a store of value? The extreme volatility of the coins argues against ever having confidence in that. Ultimately, the speculators will be forced to face that reality. I believe, like is happening in China with the RMB, digital fiat currencies, blessed by governments, will crowd out the unregulated versions. Bitcoin holders will eventually become bag holders.

So what are the other trades that are being driven by this narrative-chasing wave of hot money? I got bad news for you. Everything.

Have you ever driven a golf cart that doesn't have a governor - the safety device installed to limit the speed of the cart? Well, that's what this market feels like to me. And what, pray tell, is the market's governor when both monetary and fiscal policy are in fire-hose mode? With valuations in the top 1% of the past 30 years, investors are implicitly betting the answer is: 'nothing'.

A serious correction in markets is over-due. Most investors, when asked, are worried about it. But you'd never know it from the data. Sentiment measures are stretched, cash levels are the lowest in years and 'short volatility' positioning by speculative accounts is at six-month highs. I'm hearing a lot of talk that 'a correction would be "healthy". We will see how healthy people feel down 15% at some point soon.

By some alchemy, the strategist expectations for the market are for modestly higher markets, mostly based on earnings growth of 10%, with multiples left relatively static. They argue that higher interest rates usually accompany rising stock markets, and in past cycles, that has been true. But we are starting the year with valuations so stretched and administered rates so distorted by central bank manipulation, I discount this complacent view entirely. With such valuations, just a small rise in the 10 yr bond yield will offset any earnings-driven improvement in stock prices. Worries about bond prices are already starting to filter into market dynamics and we are only up 30 Bps from the pre-election lows. Break evens, the expected inflation rate at which inflation-protected bonds trade relative to nominals, have breached the 2% level.

I have shown this graph before. It is the yield curve. Can anybody say that we aren't going to potentially see a 250 basis point yield curve at some point this year? Once this relationship gets going, unless we see an abrupt reversal of Fed policy (as happened in the stop-start 1980 experience), it is a distinct possibility.

When looked at from a valuation perspective, there is no wiggle room for valuations. When stock earnings yields get below 3% premium to bond yields, equity prices stall. Any move from here, and we risk halting the rally in its tracks.

: Chart Courtesy J Aitkins

So keep long you momentum bulls. The good news on which you are basing your optimism won't help you make any money in the markets, but you will at least be able to get on a plane or go to a restaurant. Have you received my signal?

Risk Model: 3/5 - Risk On

Still similar to last week as the elevated price levels are generating overbought signals but the Volatility, Cu/Au and AAII signals are in buy mode. Last week saw an abrupt reversal of the copper-gold relationship that had been threatening to fail. The binary outcome (read last week's Snap Election) that saw a resolution based on the Democratic party seizing control is serving to forestall any corrective action. The Proud Boy uprising was dismissed as a non-event and the worsening pandemic and double-dip economic path are similarly being viewed as a valley to be looked over - as they should. But now that we have priced-in a seamless transition to the post-Covid world, it is incumbent on the market to at least pause while the real-world scenario plays out.