People Get Ready

"People get ready, there's a train a-comin'

You don't need no baggage, you jes' get on board"

- Curtis Mayfield

A correction is both a threat and an opportunity. The yin and yang of market behaviour is an unavoidable and necessary part of owning risk assets. That's where the 'risk' part comes in. And yet, there is a knee-jerk reaction built into our DNA that creates hesitation and fear when markets sell-off. It's only normal. But at the time it feels anything but.

What narrative is driving the angst? Partly it's the political football now being punted back and forth in Washington. This is a manufactured crisis is linked to the weaponized use of the debt ceiling. Both an arcane and useless part of the budget process, the debt ceiling has been raised over 80 times in the past sixty years. The brinksmanship is part theater, part game theory but in the end, solvable.

So like all the threats to the market, it is simply a problem of perception. But that is precisely why markets have such trouble dealing with it. We, as risk players, are constantly trying to play a game of anticipating the anticipations of others. It doesn't matter what you think. It is a process of trying to think what others are going to think.

So buy the dip that others are fading. We are still in a bull market. Markets don't die of old age, They are murdered by the Fed. Remember - the inverted curve is the biggest weapon the Fed carries and it's firmly locked up in the gun cabinet for now. The reversal of excess stimulus in the form of tapering QE is not a smoking gun, it's more like a wet noodle to the face - unpleasant, but survivable. The taper tantrum 2.0 is here and it looks pretty tame so far.

How you buy the dip isn't important other than what your future returns will look like. But until it's a process not a point in time. The happy hunting ground ( is that acceptable PC police?) seems to be small-cap. It has rarely been cheaper (chart below) and is showing good 'relative strength' during this correction period. The successful test of the 'V' shape bottom is offering us a second chance to get in!

TSX Small Cap vs GOC Bond Yields - CHEAP!

Chart courtesy: J Aitkins, TD Securities

Small-Cap vs Large-Cap - TSX

After such a long rally, it will take a bit of work to shake out the weaker players, most of whom have been caught chasing the latest Mega-Cap rally that has now failed miserably. Equity positioning remains elevated adding to the short-term risks. Earnings releases in the upcoming weeks will play an important role in shaping the correction's short-term path. The combination of Delta variant closures, intractable cost increases for materials and labour, and missed shipping connections should mean a decidedly negative surprise environment for Q3 earnings. The seasonal lowering of expectations has begun in earnest.

The bond market is pausing both to assess the debt ceiling risks and rebalance asset mix positions. Should the 81st consecutive attempt at raising the debt limit be successful, however, the resulting toxic combination of a U.S. Treasury free to issue bonds, with a Fed more reluctant to buy them, should ensure a resumption of the bond bear. The ensuing steeper yield curve should coincide with a year-end reacceleration in global economic performance due to the lessening pandemic effects.

Sounds like a trade in Financials is also shaping up nicely. After the mid-year consolidation, they are now ready to challenge the highs of early 2018 as the mid-cycle dynamics of improved net interest margins and higher loan growth starts to kick into higher gear in 2022. The Canadian Banks are like cheap bonds, with the strong possibility of higher dividends and/or buy-backs, given their excess capital and cost-cutting bias. They are like sitting duck acquisition targets for their own CFOs. My pick is BNS - but it has to be I guess.

TSX Financials vs XIU

Now before you throw the China bear case at me, I agree the property Ponzi scheme that has supported their phenomenal growth story is likely over. What replaces it is likely a slow transition to a more service-based economy, just like we saw in the OEDC after the 1980's. The demographic picture in China alone argues for this transitionary shift over the next decade. President Xi's drive to create "Common Prosperity" - a sort of Cultural Revolution Mini-Me - is certainly a threat to the 1% of that nation that controls 30% of the wealth. (Has anybody see Jack Ma lately?) But I don't think the massive inertial push of 1.3 billion consumers has reversed course significantly. Remember: 4% real GDP growth for an economy that is now 80% the size of the U.S. is still a substantial number.

Decelerating growth will not only be a feature of Chinese real estate. As we lap the 're-opening' economy of 2021, the base effect will be again at play - only in the opposite direction as this year.

This will mean a less hyperbolic headline environment that may dampen investor enthusiasm. But juxtaposed against an interest rate environment that remains unchallenging, stocks will continue to be the preferred savings vehicle for most investors. By then, the Robinhood/Bitcoin manias will have run out of steam, and patient investing will again be the norm. But from where I sit, boring is beautiful. Turning 67 will do that to you.

By the way, I prefer the Jeff Beck version to the original 'People Get Ready'. His transcendent playing behind an emotive Rod Stewart vocal is simply sublime. I can't help but wonder what Hendrix would have done with it? It remains one of my favourites. Cue it up and get ready - just like the market.

Risk Model: 1/5 - Risk Off

Unsurprisingly the Model remains in 'off' position as the choppy environment I predicted recently is in full swing. The playbook here is for a cashed-up investor to gradually deploy the surplus funds into a falling market. Using a strategy of equal-dollar commitments has merit. We won't 'know' if the correction has run its course until well after it has done so. I hope that this one will seriously challenge the 200 DMA before it's done. If it holds at the 95% level, the likelihood of a continuation of the bull market will be high and max 'risk-on' behaviour will again be appropriate. But for all I know it could already be over!