Sirius Problem

In Greek mythology, Sirius, the Dog Star, was seen to be the cause for the scorching heat of late summer. Since it rises concurrently with the sun during late July and August, the ancients blamed it for an increase in late summer temperatures. You can sort of think of this as the original version of the recently released U.N. Report on Climate Change. The science back then may have been questionable, but it has become embedded in an explicatory narrative that persists to this day. The "Dog Days" of summer are upon us.

The soporific effect of heat on human motivation is widely accepted. Aside from a few athletes in Tokoyo last week, most people have been laying low during the heat waves of recent days. Asset markets have reflected this malaise, with a resultant low volume, low volatility environment. This was evident in the flash crash in gold this week as holiday market conditions weighed on demand for 'Boomer Bitcoin'. Stock correlations have also receded, with major divergences in performance for the FAANGs (ie GOOGL vs AMZN). The choppy action is indicative of a lack of conviction and a changing narrative.

Economic momentum is similarly being dampened by a combination of supply chain outages and pandemic persistence. China's economy has been particularly weak, relative to expectations, due to both these issues. This growth rate slowdown has been the primary reason for the reversal of investor preference in the cyclical/value trades that dominated active strategies earlier this year. The Q2 drop in bond yields seemed to sus this out early, as usual.

At the same time, there is a nascent move to begin unwinding quantitative easing. In a major trial balloon initiative, a former Fed Vice-President, Bill Dudley, was quoted yesterday as saying yields will begin to rise once the unwinding begins. Former Fed officials never say anything publicly that hasn't been vetted by the current Chairman, so it may as well have been Powell saying it. On cue, bonds have begun to sell off, in price terms, in preparation for the step function change in demand that results from the change in Fed policy. They have gone from 'not thinking about thinking' in Q1 to 'thinking about it' in Q2, to now 'talking about doing it'.

By Q4, I think they actually 'do it'.

Readers of this space may want to review my missive of July 20 that advocated a 'sell on bonds' position. At that time, I was arguing for a resumption of growth momentum that would occur after the Delta wave of the pandemic as the catalyst. The Fed, in the near term, will likely hold off on its efforts of removing accommodation as the Covid case count rises. That could mean a choppy back-and-forth for bond yields in the near term. But once it is clear that the case count has begun to again recede, the bond bear can resume in earnest.

Risk asset prices have been kept levitated, indirectly, by the artificial bid to bonds from central banks. The risk that the unwinding of that bid from a non-economic buyer becomes disorderly is currently generating a bit of investor caution - you can see it in the sentiment surveys this month. A stealth correction in the market led by value and cyclical stocks, combined with a huge backfill of valuations that resulted from spectacular earnings growth has the market primed for the big event. Who on earth doesn't already know that the Fed will stop buying bonds at some time this cycle?

The tanks are massing at the border, waiting for the first signs that the war (on easing) has begun.

Until then, we have a series of random walks down Wall Street in the searing heat. I'm just glad I'm not a dog.

Risk Model: 2/5 - Risk Off

A market that just won't correct is like a euchre hand that has two high trump, a 10, and a couple of offsuit 9's. You want to 'make it' but you just don't have a lot of conviction. The only positives in the model are currently 3mo Vix and Copper/Gold. Those are strong trump cards. Unfortunately, the RSI is elevated, stocks are well above the 200 dma, and the AAII sentiment has turned sour.

I'm gonna sit this hand out. Pass.