The Last Mile

With a week to go until the U.S. election, it feels more like a mile. The outcome is still in doubt, but more importantly, it will soon be over. And that's all that counts. In the last few posts, I have been adamant in my views that markets will rally, post-election. The "Purple Wave" is about to wash up on the beach and I don't care if it's Blue or Red tinged. Markets, still a touch over-bought, are pulling back, as I had postulated. Using phrases like 'more wood to chop' and 'jumping the gun', I counselled caution over the past few weeks. But as we get called back for a false start, it's time to go all in.

Although the incidence rate of COVID has spiked recently, the markets have been pre-conditioned by warnings of a seasonal uptick, as more indoor activities and school openings occurred. But this has been expected for months. Positive signs from the medical trials (Merk today) and a sense of optimism regarding a 2021 vaccine roll-out are sufficient offsets to the bearish fears surrounding the current surge of infections.

As always, the removal of uncertainty will be the main market-moving catalyst. And no, I don't believe the hung jury scenario of a contested election will do anything but delay the inevitable. Investors have seemingly been totally absorbed with the political and COVID news flows. But markets respond primarily to monetary and fiscal drivers, which are universally positive. Politics, currently the number one topic on investors' minds, is wildly over-emphasized as an input. And more importantly, at the micro-level, the markets are full of good news.

With earnings season in full swing, the nascent strength of the post-COVID economy is becoming evident. Durable Goods orders in September blew the doors off the estimates. So far, over 80% of earnings reports have been 'beats', and not just from the 'Stay at Home' stocks that have been favoured in the last 6 months. Harley Davidson (Peloton for fat Boomers) reported strong results. CAT was a beat, despite a perception that the global economy is doomed. Banks reported mostly improved results.

Mergers are also driving a positive wave of corporate restructuring. The block-buster AMD-XLNX deal is unequivocally positive for the chip makers. In Canada, CVE and HSE are combining in a deal that looks like two drunks holding each other up. Creative destruction at work, as Professor Schumpeter would have said. Both companies are better for it.

So are the down days over? Who knows? I'm just saying that the fears of a market top market hinge on one thing. Uncertainty.

And what pray tell would create this dear Pundit? By definition, we don't know. markets usually drop when a 'new' fear replaces an existing complacency. It may happen, but nobody can see it yet. But that's why the stock market is inherently risky. So, while I'm max-bullish, I don't profess to be clairvoyant. Bet only what you can comfortably risk.

So with most of the currently posited risk elements sufficiently disseminated, so we can dismiss them as market drivers for anything more than daily volatility. I'm still sticking with the call for a broadening economy that allows for a rising market into next year. The trajectory should be less steep. It should also express more idiosyncratic risk. But the pain trade is higher, in my view. The 'tri-furcated' market ( read May 5th's "LUV IT") still will exist but the Value and COVID-impaired Consumer Discretionary stocks are full of opportunities. Despite the current negative news flow, nervous investors can look forward to better times in a few short months. The 'mean reversion' trade still represents the most compelling long-shot bet.

Long Delta Airlines, short Zoom anyone?

RISK MODEL: 2/5 - RISK OFF

A drop in the markets has kicked the model into a slightly bearish tilt, the culprits being a drop in the RSI and a rise in the VIX. As to the latter, the term structure of the futures market for volatility is instructive. I would be more worried about a major sell-off if the ratio of 3 month and spot volatility was high. As the chart shows, when the 'out' months are below the 'near' month, as is currently the case, risk-taking is ultimately rewarded by a subsequent market rise.

3 Mo VXV / VIX