Song of the Summer

According to Billboard, the song of the summer is 'Butter' by Korean boy band BTS. Not that I listen to such stuff, but it does reflect the times that a disposable, overproduced ditty is the best we can come up with. I predict this 'Butter' will soon melt from our consciousness into a disposable mess at the bottom of the dish.

Often the summertime markets are low-volume affairs as the decision-makers head to their various vacation haunts and turn off their screens. Complacency abounds, especially following the record-setting rally as we saw in the first half of 2021. A slow-motion rally in the stock market since the last Fed meeting has perpetuated the belief that all is OK with the restart of the economy and the policy mix that has supported it. We have returned to the low rate, growth stock leadership that characterized last year's rally. But that seems like a default position rather than renewed theme. The cyclical positioning that active managers counted on in Q1 to out-perform the averages is also looking like a stick of butter left out on the counter to melt in the summer heat.

Commodities are breaking their uptrends, one by one, as supply shortages are being worked through.

Lumber is down $700 from the peak levels set in the spring. Steel, copper, and agricultural prices have crested, creating a loss of momentum for the hard asset trade. Only oil has held firm lately, reflecting the lagged effect on demand from the slowdown of the global transportation system. And now we are seeing the unravelling of OPEC+. The refusal of the UAE to play by the rules being dictated by the Saudis is a death knell of the cosy club that has held prices above market-clearing levels that seem to be closer to $60 than the current $75 level.

Economic surprise (see chart) has rapidly decelerated from the unprecedented gyrations in 2020 that were exacerbated by the pandemic. Now we are likely to see them follow the bond market's lead by dropping below the market's expectations. Bond yields are now signalling a significant pause in economic momentum that will develop over the next two quarters. Factors that will contribute to that slowness are being ignored. The Global economy is not recovering nearly as fast as the U.S. due to an uneven vaccination roll-out. China is damping down the commodity rally and ramping up its intervention in the tech sector. Anybody who bought into the DIDI IPO should know that all too well.

The navel-gazing portfolio managers and retail punters on Wall Street never seem to clue in until it's too late. The AAII bullishness, as well as other sentiment surveys, reflect a dangerous consensus that is at odds with the potential threats from a rolling-off of the stimulus that has propped up the economy this year. Bullish growth forecasts, that were late to be developed this year, are suddenly looking well ahead of the curve of actual economic growth, now set to disappoint.

CitiGroup Surprise Index

The Q1 earnings reports that encouraged us that markets are 'growing into' their valuations won't be enough in the upcoming Q2 data dump. They will most likely be viewed as 'peak' for the year. The margin enhancing one-off price effects experienced this year will be increasingly offset by the lagged effect of cost increases, just as companies regain their momentum. As I pointed out recently, it is the second derivative of growth that matters to markets. That is what drives "the expectations of others" and I expect earnings expectations to start to melt away this summer.

Just like a hot stick of butter.

Risk Model 2/5 - Risk Off

Optimistic AAII returned to their bullish ways after ducking the FED in mid-June. The low volatility environment persists, generating the second of the two positive Model readings - $VXV.

The elevated level for risk assets looks much the same as it has for most of the year and the 'porpoising' action has once again generated new highs. This time the re-rotation to mega-cap growth was the sole source of strength beyond the oil stocks. How much Apple and Facebook can one own?!! Breadth and volume have continued to lag. Summer rallies are often ephemeral and often lead to corrections - hence the seasonality of returns. I'm sticking to my correction call.

West Texas Intermediate

The recent move to challenge $75 was unsupported by concomitant volume support. Sell.