Sneak Peak

I guess we shouldn't be surprised by the market action last week. When you have too much cash burning a hole in your pocket, or in this case money market funds, you tend to buy first and ask questions later. So a "rally of everything" just happened. Now, second sober thoughts have begun to creep in. Tony Dwyer has called for chillaxing. I agree, but the inter-market action may have a dual meaning as implied by the title above.

It's perhaps given us a clue what a 2024 narrative could look like. There has been a noticeable rotation to the left-for-dead small-caps, hard assets, and financials, with a sharp drop in the Magnificent 7. It's all very hopeful to think about a broader market - one in which the banks participate fully. ( I long for the end of "no banks, no thanks"). But I fear we have much work to do before that happier time is sustainable.

The short-term market highs - I called it the "Turkey Top" - have come quickly on the heels of the "Dimon Bottom" of just 4 weeks ago. Quite the whipsaw for the bears but is it a false dawn for the bulls? Perhaps, but the unemployment readings in the U.S. have tentatively begun to confirm the soft part of the "soft landing" scenario. Should these data continue to weaken, the Fed will have a new conundrum on its hands. It now risks being behind the curve, except in reverse - too tight for too long.

Their internal debate is just beginning. The FOMC is divided on the future of the economy. Is the nascent weakness in the labour market real or is it 'transitory'? Therein lies the decision. Can they actually thread the needle and generate the 'landing' part of a 'soft landing'? The data this week, especially Initial Claims on thursday, will be critical for their choice. Watch the tape carefully for clues.

Unfortunately for the optimists, Chair Powell's skill set is more aligned with the legal profession than with those of a carrier pilot. Especially now that the deck of the economic ship is pitching wildly. He will want more evidence before re-using Bush's "Mission Accomplished" banner. How'd that one go, Dubya?

He doesn't see the inherent weakness of his flawed decision tree. I'm calling the Fed out on this one! You can't be historical-data-dependent while at the same time believing in the "long and variable lags" inherent in the exercise of monetary policy. How do you square the two - you can't!

This leaves me with a sense of foreboding about January and the early part of 2024. Many owners of the narrow list of over-priced growth stocks are waiting for the new tax year before taking profits. And any premature rotation to the underperformers of 2023 risks buying into the deceleration in cyclical earnings as employment wanes. Inflation in goods is much easier to tame than in services. That supports the notion of stubborn inflation risks and the higher-for-longer mantra from the Fed. It doesn't support the FOMO chase in all risk assets we have just seen.

I am convinced that we have seen the highs in bond yields. I can't say the same thing for the lows in stocks, at least relative to the October levels. We may need to test those levels early next year. Just being convinced that the Fed is not going to hike isn't enough. We now need to be convinced that they need to cut. Stocks have embedded 4-5 quarter-point cuts for next year on little or no evidence that the economy is actually on a path to the widely predicated soft-landing regime.

So I think we have the playbook for the year ahead. Just as '23 was a mirror image of '22 in terms of leadership, I'm hoping for a regime change. We got a peek of it this week.

Unfortunately, in the short term, a painful peak has to be negotiated first.

Risk Model: 2/5 - Risk Off

With the over-bought condition likely to persist during this period of positive seasonality and low volumes, I think the sidelines are a welcome place to sit. The failure of copper to best gold is confirmation that the weakness in the economy is still dominating the narrative. Oil has joined the real economy's pity party by dropping, even in the face of OPEC saber rattling. China has fallen and can't get up. Volatility and AAII measures are the only positives as complacency dominates sentiment.

Gold has broken out of a base of some consequence. It responded to the same impulse that drove many moves lately - the prospect of a friendlier Fed that weakens the U.S. dollar's hegemony over global assets. But that presumes real rates that are lower than current levels, especially in the front end of the curve. As is true of many risk assets, it looks a bit premature to call a bull market just yet, but once the Fed cuts, look out! The pattern counts to at least $2,500/oz.

Gold

Bitcoin has the added accelerant of its pending approval for ETF status. If that isn't a sell-on-news opportunity, I've never seen one. But like all hard assets, it is a pull-back that should be bought. Again the Fed's response to weaker data, when it arrives, should generate a sustained rally next year. Levels above $100,00 per coin aren't out of the question then.

Bitcoin