Steamroller Blues

Leave to Elvis to cover a James Taylor song and make a hit out of it. They couldn't be more different and yet they were both huge stars in their own right. It's sort of like growth and value stocks. Style vs Substance. Flashy vs Rootsy. Made-up vs Original. I know which I prefer.

There is another steamroller analogy that comes to mind with the markets elevated while fewer and fewer stocks make new highs. The chart below indicates the lack of participation by many stocks while the averages reach ever-higher levels.

Without a broadening in participation, buying into this market is like picking up nickels in front of a steamroller.

NYSE Net New Highs

The bond market rally over the past three months has provided the incentive for just such activity by again lowering the cost of money. The resulting melt-up in asset prices has created a dangerous backdrop for prudent investors looking to allocate capital without taking huge risks. As I said last week, the bad news on the economy has been, perversely, the driver of these higher asset prices as investors have given up on the taper tantrum scenario. A benign Fed is the bull's favourite friend.

As less money enters the market, fewer stocks validate the new high levels and investor angst grows. Volume validation is missing, as shown in the Chaiken chart below:

S&P 500

The AAII Bull/Bear survey is stuck in risk-off mode. Investors have turned cautious but I do not view this as a contrarian indicator as yet. We need them to turn bullish to flash a buy signal.

AAII Bull/Bear Ratio

Unless the bond market gets a whiff of economic acceleration and sells off sharply, there won't be much change to the scenario. Encouragingly. this past week saw a different reaction by fixed-income investors to the weaker than expected employment data - the long end yields rose, thereby steepening the curve. This looks to me as a preparatory move in advance of a post QE, post-Delta phase of the economy that should arrive by year-end. Stock investors have, as yet, not begun to look over the valley to a stronger more inflationary environment, as demonstrated by their continued infatuation with growth over value.

The reflation trade has round-tripped. Stocks that benefit from higher rates could actually start to outperform, thereby averting a major correction in the averages, but I doubt it. As long as growth expectations continue to ratchet down, the nickles will continue to get picked up.

Risk Model: 1/5 - Risk Off

With the RSI above 60 and the Copper/Gold Ratio falling again, the model is cautious. Only the lack of volatility is preventing a bearish clean sweep. I have shown the VIX chart before so I needn't repeat it, but will the seasonal correction period come and go with a whimper or will the pullback suddenly burst on the scene? Stay tuned to this channel!