Oil be Damned!

Biden and MBS doing their pre-fight fistbump

Just when you thought the bank crisis was the only thing that mattered, the Saudis have put paid to that notion. The market seemed to shrug it off yesterday, but don't be fooled. An inexorable cost creep has reemerged. Corporate profits are headed lower! Bond prices seem to have figured out the narrative as long-end yield levels dropped more that the 2 yr version. That tells me that the new narrative is less about inflation and more akin to the stagflation last seen when I was a newlywed toiling away at Biz school in the late '70s.

The inflationary implications of the sudden bid to the crude market are not substantial in and of themselves. What it does reflect, however, is the rigidity of the cost structure of the post-Covid economy. The profit outlooks that underpin the valuations of a broad swath of the equity market are now under threat of downward revision. More importantly, the rigid labour markets and the lagged cost effects from the reshoring and greening of the economy are major threats to corporate profits as well. Simultaneously, the credit squeeze has just begun to bite down on aggregate demand. There's little upside to the tighter lending standards that are just now being implemented. Bad news is not good news now!

I have no idea what has driven the optimism in the latest risk asset rally, other than too much money chasing too few things. Although the surge in money market assets would lead you to believe that there is lots of unrisked cash still on the sidelines, it simply reflects a structural shift in the deposit preference for the higher short-term yields available in those products. Banks, especially those who relied on cheap low-rate savings accounts are still under the gun. Their market-to-market losses on their balance sheets are a ticking time bomb that seems to be strangely ignored by investors.

A solvency 'fix' has been offered by the Fed - the BTFP- the Bank Term Funding Program. (I guess we really didn't run out of financial band-aid acronyms in 2008!) This stop-gap measure has allowed a reflex rally to push "the market" to post-2022 highs, led by the QQQ growth segment. I put the quotation marks in because the broad averages were narrowly concentrated by the mega-cap growth plays and goosed by the oil bounce. It's a market that I believe to be more bullshit than bull.

Can a rally that has left the regional banks in the dust and was led by the likes of a cash-rich, perma-bull favourite, AAPL, truly represent the beginning of a durable expansion of risk assets? Not in my 40+ years of watching the start of at least 7 different versions of major cyclical advances! No Banks - No thanks!

Banks are not just 'widow and orphan' dividend plays. Their systemic importance to the business cycle cannot be understated. Savings and investment are the oxygen and nutrients of an organic financial system. Without them functioning properly, the economy, and by extension, the stock market, lives or dies. The patient has been stabilized but is still in intensive care judging by the feeble bounce in the financials this past week. I'm not happy!

Financial Sector - Relative Performance

I cannot get behind the technical arguments being offered such as those showing a "break out". Do you see any confirmation from the equal-weighted version of the S&P500 in the chart below? All I see is a head fake from the non-cyclical market heavyweights. It's probably a reflection of the passive investment craze as a disproportionate amount of fund flows are mandated to the momentum winners of the past. Again, where is the new leadership going to come from?

RSP - Equal Weighted S&P500

So excuse me for being a Debbie Downer this morning. My scenario of a choppy upward, but ultimately failing, equity rally that stemmed from the sentiment/positioning lows of last fall is playing out perfectly. Ominously, the mother of all 'sell in May and go away' tops is similarly shaping up as well. Until the Fed is in a position to effect a true pivot based on economic duress that is sufficiently pronounced and yet to occur, this latest advance will turn out to be just another failed attempt driven by FOMO. Until then, the costs of pushing the economic rock up the hill will eat away at profits and ultimately the residual optimism that has sucked in the latest short-coverers and quarter-end window dressers.

The final straw in the 2008 financial crisis was the speculative run in crude driven by the 'peak oil' fantasy. This time it seems to be more similar to the 1974 oil embargo. Either way, higher energy costs could tip the precarious balance now supporting risk asset accumulation. The give-up phase seems to still be ahead of us despite the upward bias to the markets. Oil be damned if doesn't come soon.

Risk Model: 2/5 - Risk Off

I'm fudging the model a little this week as the upthrust crests into the upcoming employment data. The RSI (just below the signal line) seems destined to turn to the off position this week if today's rally extends to mid-week. A quarter-end, position-squaring retreat from the bears depressed the $VIX to an artificially low level and insurance is cheaper now that at any time since the October low. I'm buying UVXY and SQQQ today.

VIX and S&P500

Copper/Gold is continuing to work lower this week as the recessionary implications of higher for longer rates, a credit crunch, and higher energy costs erode speculative confidence in the Red Metal. Stocks don't like a breakdown in this measure for good reason especially those in the value segment dominated by cyclicals and banks (IWD shown in the lower panel)!

Cu/Au & IWD (Value ETF)