Offside

Now that the playoffs have begun I can dust off the hockey-related financial market references. With hope still springing eternal, Leafs Nation will again cheer their team on to victory tonight, despite all evidence to the contrary. And before you paint me as a Leaf hater, know that I have a long history of fandom for the Blue and White. My first hockey memories stem from a grainy image on a black-and-white RCA in my rec room where the family gathered over our Swanson TV dinners to watch the early version of HNIC. The Toronto broadcast started at 8:30 EST after the Tommy Hunter Show, but I was living in Vancouver and cheering for the Maple Leafs. We could listen to Ward Cornell's call from the Gondola til bedtime at 8 local time, even though I never saw a first or last period til we moved to Kitchener in 1966!

Somewhere along the way, I lost my unquestioned fealty to the hapless Carlton St crew. It could have been the influence of Kitchener Rangers whose games I attended, or maybe the rise of such stars as Vic Hadfield and Walter Tkaczuk, but I soon found myself rooting for New York. Later when Bobby Orr and Serge Savard broke in, I was more interested in the many epic Bruins/Habs series as the post-'67 Leafs perennially flamed out and drifted into irrelevance. The Ballard years put a final nail in the coffin by mismanaging the franchise into a competitive coma in which they still find themselves suffering. I learned to stay agnostic on the prospects of success for a particular team from that bitter experience.

Perhaps that gave me a skeptical persona that has informed my investment career. I have never trusted blind loyalty to any investment theme, no matter how well-reasoned or logical it appeared. Coupled with a healthy dose of self-doubt and insecurity, my level of confidence in my ability to forecast the future course of stock market movements has never been as high as you may think it was. The phrase 'forecast and forecast often' was invented for me.

Hence I find myself unable to justify my view of impending doom that I expressed last week. Maybe it's a case of a 'little knowledge is dangerous', but the call for shorting this market has been a bad one so far.

It's not that I haven't consistently argued markets will have an upward bias in the first half of the year - which has been correct. I just haven't played the tactical side of this trade very well. There isn't a strong enough case from the Bears right now to play the downside.

The soft landing theme is gaining real traction due to a resillient consumer who continues to spend on small ticket items that dominate the service economy. Restaurants and airports are full, as the 'Covid Cooped-Up' venture forth to experience what was denied to them during the long lockdown.

Lower inflation prints are leading to a fundamental case for lower yields, cushioning the blow to housing and autos. Rapid stabilization of the banking system has bolstered investor confidence in the outlook and snuffed out any potential panic contagion. And this morning we saw evidence that the rebound in China is better than expected, further bolstering the optimistic case. The rally is alive!

But is it possible to survive a 450 basis point rise in rates without major economic dislocation that leads to a recession? Maybe, when you come from a place that we have never been - the zero world of QE and Fed rate repression - behavioral anchoring to a world of 25 bip Fed Funds may be at work here. Rates only seem high because they were so low for so long. As my homebuilder brother-in-law said to me, 7% mortgages haven't stopped me from selling out this year.

I'm indebted to the redoubtable Ian de Verteuil of CIBC for sending me his recent piece which he posits a world where companies, having the ability to pass along costs (including debt charges), maintain a sufficient level of profitability to attract investors away from their fixed income hide-outs. It would look a lot like the post-1974 oil shock where bonds didn't cover inflation so stocks were seen as the only alternative. TINA may have morphed from a 'nominal argument' during the zero yield era post-GFC to a 'zero real' rate era where bond yields don't rise above a persistent 2-4% inflation bogey.

That makes virtually all the bearish arguments against equities offside, at least for now. Companies would have enough earnings power to stand up to the new rate structure, while persistent low 'real' rates would diminish the relative attractiveness of bonds. Ian also points to a weak dollar and strong gold for corroboration of this argument. High-yield credit spreads are not even close to reflecting the stresses that the equity bears are touting.

Inflation would be good for stocks as long as the Fed allows it to be untamed. As we have seen, they are slaves to the trailing data. It would then follow they will soon be fooled into thinking that their inflation fight is over this year, especially as the data continues to lap easier comps. Remember, U.S. gasoline prices peaked at over $4 in July last year. They are currently in the mid $3s. Food and lumber costs are similarly flat to down. Inflation is statistically challenged now.

We still have to survive the seasonality of an impending May peak (short covering capitulation?) and the usual Fall sell-off this year. But as I have already proven, I don't know from what level those inflection points will come. If the weak breadth of the market resolves from a catch-up phase from the mid and small-cap segments, it will have been a case of 'generals lead and troops follow'. Watch for volume and breadth to expand for confirmation for that scenario to play out.

A rolling recession that started with the speculative financial sector and is now eating away at commercial real estate is a double-edged sword. This area of the economy is directly affected by rate hikes and structural forces from WFH. But more generally, service industries are proving to be more immune to rate pressures. This combination of factors should help to halt inflation at current levels without too much damage to overall employment.

The lower rate structure of 2 years and beyond is a forecast of inflation stability that falls to +/- 3%. Only in the front end do we see stressful levels above 4%. It is incumbent on the Fed now to solidify the yield curve's forecast with rate cuts sufficient to reverse the effects of that inversion. Should we get a series of confirming data that inflation is dropping (read David Rosenberg for the bullish argument here), we could get them soon than expected. More importantly, the all-important Fed reversal in forward guidance will cement the narrative for the bullish case well before that.

It's hard to believe that the crowd could be so wrong about a hard recession given the many indicators that support that view - primarily the inverted curve that I have cheered for like a 6-year-old watching a Leaf game. And how has worked out for you over the past 56 years Bob? I'm blowing the whistle on my offside call from last week. Again the market loves to do what makes the most people wrong - and that apparently includes me!

Risk Model: 3/5 - Risk On

The model has had it right for a few weeks now as the VXV and AAII bullishness combined with a lack of downside follow-through from the banking crisis has righted the ship.

The RSI is slightly overbought as the buyers push to a post-recovery high. I wouldn't chase the markets here as earnings reports will drive choppy action after the post-SVB bounce. But shorting this market is dangerous given how crowded that trade has become. Hedge funds are still max-bearish and B of A surveys show equity commitments at record lows.

The Cu/Au is still lagging. Could it be that the rolling recession hitting the goods part of the economy is to blame? That would only continue the Growth over Value trade higher from here.