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Respite Rally








When a caregiver has reached the end of their rope, respite care is often necessary to provide relief. Are we at that point for the markets? Is it time to call in the professionals to help?


Investor optimism has plunged recently. A decade low in optimism could be a signal of an investor that has had enough and needs a break from the gloom. In a world of choppy, weak risk-asset performance, juxtaposed with a still-growing economy, the swing factor becomes investor sentiment. And as has been widely reported, sentiment has been dismal (chart).


AAII Sentiment: Bull/Bear



But don't we need a catalyst to break out of our funk? Earnings reports are often just what is needed to change the narrative. This week will be the test.


Fundamental factors such as valuation and earnings growth have improved rapidly thanks to the flow-through of monetary support of the financial markets to the real world. With the earnings report on deck this week we will get a much-needed distraction from the global macro-dominated news tape. A bit of a respite from bad news would certainly be welcome.


Big Tech - Microsoft, Apple, Google, and Amazon (I refuse to use the resulting acronym) have emerged as the go-to growth vehicles now that Netflix and Facebook have been dropped from the group like exhausted bike riders whose legs have given out. The Twitter take-over has galvanized the tech bulls, despite the spurious correlation between Musk's newest vanity project and the plentiful investment opportunities that have arisen from the Nasdaq correction. I'm looking for the mega-cap stocks to lead a rally as they react favourably to their earnings reports this week.


The safety valve for investors fearful of endless rate hikes is the self-inflicted economic slowdown in China. Bonds acted well yesterday for the first time and this has sparked a sudden shift in the 'stagflation' narrative, putting the emphasis on the 'stag' rather than the 'flation' obsession of last week. Bond markets were deeply oversold (chart) and due for a bounce. Reflexively, "growth' assets rallied smartly off yesterday's mid-morning lows and staved off the equity rout. Today's low volume drift lower seems to lack conviction.




iShares 20+ Treasury Bond ETF - 12wk ROC




Market reaction to earnings season so far has been asymmetrical, as 'beats' were ignored and stocks reporting 'misses' were pummeled. Many companies are generating strong results, but the interest rate turmoil has masked the positives. That has provided at least a trading opportunity to apply a fundamental sharp pencil to one's portfolio. Picking away at strong businesses in weak markets is the hallmark of all great investors. United Airlines, Apple, and Bank of America are strong businesses in case you didn't know. So too are Air Canada, Shopify, and BMO.


Although oil has reacted negatively to China's artificial growth scare from their Covid shut-downs, that should be transitory. Either the shutdowns will work, or more likely, Bejing will reverse course and goose the economy with infrastructure-based stimulus. The effect of SPR supply releases and the post-winter seasonality should soon be overwhelmed by the intractable Russian supply shock. The potential threat of removal of 3-4 mm bbls of hard-to-replace daily production from global markets at a time of tight inventories should provide persistent tailwinds to the crude market throughout this year.


The bounce in risk-on plays could be short-lived, however. In a choppy environment like this, the trades will have a short shelf-life, measured in weeks if not days. China's demand for commodities is still the dominant factor and their property sector decline is still a more substantial, almost existential threat to the China growth story. The soft landing scenario for the global economy lives and dies in the land of the Red Dragon. Crude oil could also come under further pressure should Germany ultimately succeed in moving away from its disastrously failed Russian appeasement strategy.


A Fed policy error is also in the cards given their habit of driving in the rear-view mirror - but that's a risk for later this year. So I don't think we are through with the repricing of the bond market. In a post-QE era, the removal of the famous 'Fed Put' will once again present major challenges to the market both from a valuation and growth point of view. There is some unfinished business here as markets wean off their dependency on free money from a now hostile FOMC. This recent bond bounce could mark the end of the sub-three percent long bond, save for another unforeseen risk-off event.


So look at the market as a bit of a fixer-upper. It's got good bones but needs some work. And as anybody who has embarked on a renovation project knows, it always takes longer and costs more than you think.


Risk Model: 1/5 -Risk Off


A classic Tuesat11 moment is upon us! The residual selling in the market this morning should soon die off allowing for a clean slate of risk-taking to develop from the earnings reports this week. If the volatility model shown below is to be believed, when the spot VIX approaches the 3-mo VXV we usually see markets make a short-term bottom. There is a saying on the Street that "they don't ring a bell at the bottom".


To that, I say "Ding-ding".


$VIX/$VXV Ratio - $SPX Lows



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