Naughty & Nice

As most readers all know, I usually take a moment during the Christmas season to recap the blog from the past year. It's my attempt to appraise the value of the seemingly mindless drivel emanating from my ever-curious mind that I foist upon the unsuspecting blogosphere each week. You have to admit that not every strategist you read has both the hutzpah to promote his successes and the guts to fess up to his failings, but when you are in the business of predicting an event as random as the direction of stock prices, it comes with the territory. No revisionist history or fake news here, just the truth. No wonder Fox Business news has never called me for a quote!

In June I took time to do a "Recap". I had a good first half catching the growth-to-value rotation and then locking in that trade. I predicted a top in commodities and warned of an end to the over-hyped re-opening trade in Q2. I did correctly warn of the rise in interest rates but did not see the truncated variant-driven end to the rate rally and underestimated the effect of dovish monetary policies on Bitcoin and growth stocks that put them firmly back into the leadership role for the second half of the year.

I have spent most of the second half of the year looking for a return to favor of value stocks. Frustratingly both China and Omicron have drastically delayed that long-awaited re-rotation. I sat in a high cash position and completely missed the return of the growth trade (although I did get short Tesla at $1200 as revenge). I was confident that oil prices would be capped by the restart of production, but, to my surprise, OPEC consistently stayed behind the curve of rising demand thereby supporting the rally in the best performing group of the year, Oil& Gas. I missed the sharp October energy rally as a result.

As to the broader market, I was cautious going into September but by early October I was back in buy mode as explained in Oct 5th's "People Get Ready" piece. Then I over-thunk it! Looking for a test of the September lows, I was left scrambling to get in - but at least I did. Short term-itis!

I also gave mea culpa on why oil was stronger than I expected (supply discipline combined with a cap-ex chill). The rally didn't last long though and I predicted that China's growth slowdown would cap the rise of commodities. That has been a good call - albeit aided by the onset of Omicron. Copper has been similarly unrewarding and I am on the sidelines waiting for a definitive break in the Copper/Gold ratio. My November call on gold stocks was as an alternative should the market corrected was a 'fail'. When gold stocks broke down on the strong U.S. dollar rally, I unwound that hedge at a small loss. Boomer Bitcoin has been disappointing. It will be back at some point.

In the fourth quarter, the market became dominated by mega-cap growth stocks prompting a dangerous move to new highs, led by an unholy alliance of Apple, Microsoft, Netflix, and Tesla. The 'poor breadth' rally in November was the ultimate example of the FOMO/TINA force-fed bull market. Five stocks accounted for 40% of the move. I was highly skeptical the whole time. By late November I was looking for a corrective volatility spike and it came quickly on the back of Omicron and Fed fears. I was correct to worry, as we see that Apple and Microsoft are now clothes-free emperors. Last year's 'PM to the Stars', Cathie Wood, is now in the fourth quartile as her over the horizon investing approach fell out of favour. What a messy end to a great year!

Importantly, I was correct in questioning the huge consensus on rising interest rates. The announced end of QE and the introduction of the infrastructure bill in the U.S. hasn't created the 2%+ environment most have been looking for. The combination of a decelerating recovery in global growth and a glut of savings has kept the key U.S. bond market from responding to the normal domestic cyclical forces, especially inflation. This structural miss-match will continue to confiscate real wealth from savers for many months to come should the economy continue to disappoint. Stagflationary environments are hard on fixed income investors and I have called for the U.S. Fed to introduce 'QT' to unwind the damage from their meddling. I believe the inflation scare will die down next year and I think the bond market smells that already. The Fed has a lot of work to do!

So, all-in-all, the markets were harder to get right in the back half of the year - as they usually are. A pronounced pall of fear - almost a give-up phase - now prevails as we enter the uncharted waters of the third pandemic year without the Fed to cover our collective asses. A ragged, choppy market has developed, descending like a black cloud, just as we were looking for a better 2022. Canceled travel plans and shut-downs are multiplying. A depressingly quiet New Year's is pretty much assured. I can't say I'm looking forward to our trip to Florida in late January either!

Thankfully, most of the damage to markets has likely been done. As I said last week, the only remaining element of the market correction was for the generals to join their troops in a retreat. Check. Now that the more defensive sectors (Utilities, Healthcare, and Reits) have assumed temporary leadership, the new year will soon start with a blank slate with plenty of opportunities to profit. The left-behind small caps and the value/cyclical trade still await good news on the pandemic for them to start working again. They are cheap and unloved but lack momentum. The number of good quality companies with unchallenging valuations is multiplying. Large-cap growth has soaked up enough cash for the time being and a long period of underperformance seems likely. Short-term, a muddle-through phase is the most likely outcome. Meanwhile, I'm buying a few tax-loss candidates for the traditional January bounce.

I want to express my thanks to the readership and especially to those of you who have taken the time to reach out to express your opinions, offer corrections to my typos, or present thoughtful rebuttals to my misguided rants. I am privileged to have an audience for my views. Nobody has a monopoly on the truth but we all have the right to express our thoughts, however random they may be. I thank you for your indulgence. My quest is simply to 'anticipate the anticipations of others', no matter what they may be, and turn those insights into action. It's always challenging, but what a great way to spend retirement!

The basic construct of the market is still supportive. Risk premia are generous, especially ex-tech, and the direction of growth is still positive. The Fed is getting off the accelerator but is still a long way from applying the brakes. Most importantly, the 'crowd' has given up on the re-opening trade by chasing the defensive trade yet again. I'm gonna stay bullish on equities until the global economy gets firing on all cylinders again. By then it will be front-page news and the time to really get bearish will arrive as rates rise to choke off the rally. Meantime buying good companies at reasonable prices and holding on to them is, and will continue to be, the best way of building long-term wealth. My job is only to offer a few observations that may be helpful in keeping everyone grounded if not a little bit entertained.

Oh well, it's a living. But look on the bright side, the hours may be long, but at least the pay is bad!

Cheers, and stay safe,

Bob.

S&P 500 2021

By the way, if you want to play the post-Covid economy, this stock is one way to go! It's been backstopped financially and is now levered to the return to normal. Pent-up travel demand is building. Should pandemic fears again peak, this company will print cash like never before. It's a low-risk entry point for a company that gives you a lottery ticket to a better world. And that better world is coming. I anticipate that!

Air Canada

Risk Model: 2/5 - Risk Off

The bounce this am will need to hold for the price variables (RSI & 200DMA) to stay in 'buy' mode.

Unfortunately, we will need a few more days to see volatility drop enough to signal 'risk on'.

The lagging variable this time may be AAII Bullish sentiment which is currently deeply pessimistic after the twin hits from Omicron and the Fed.

Volatility, as measured by the VXV, has remained higher than average since the advent of the pandemic.

We may not see readings consistently below 20 for very much longer if this parabola holds.

3 Month VXV - 2012-21