Think Again

Just like the Fed Chair, I'm not 'thinking about thinking' of selling all my stocks.

But having painted himself into the mother of all corners by virtually promising markets he won't tighten monetary conditions, Jerome Powell will eventually have a problem. With the hype surrounding the reopening of the U.S economy reaching a fever pitch, pressure to start the process of unwinding market support is building. To be fair, he never said 'never' when it came to changing the Fed strategy that has been responsible for the monster rally in risk assets over the past year. But he has tied his wagon to the labour market as the focal point of his supporting data. And, as we have already seen, employment is a lagging indicator. Therefore he is committed to staying "behind the curve". This Friday's employment report will test his patience should it print a blow-out number.

Markets have begun to detrend, as they pause to evaluate the relevant data and reassess the post-reopening economic prospects. The concurrent data recently reported have been unequivocally stellar. The market's "meh" reaction, however, is understandable, given the huge run-up in the prior 12 months. Some are arguing this poor response to a huge upside surprise indicates a market in dire need of a correction. The counter-argument to this bearish interpretation runs along the lines of: stocks are still producing earnings growth and look attractive as they grow into their valuations.

But does this morning's saber-rattling in the skies over Taiwan shift the focus to the problems outside of the U.S.-centric narrative that has, so far, ignored bad news? Does the worsening pandemic news from India, Brazil, and South-East Asia derail, temporarily, the upside recovery euphoria? Are the signals from the bond market, now having failed to maintain the upside momentum that caught many off-guard last quarter, a sign of a potential trend change for equities?

Since the bottom of this market, investment commentators of all stripes, including certain retired PMs who like guitars, bikes, and golf, have gotten the U.S. recovery wrong by being too cautious. The data may be transitory, inflated by the statistical lapping of the sudden Covid shock, but it is signaling a better than expected economy. The Fed and the bond market seem willing to look past this. Now stocks seem to have joined the ranks of the unconvinced, "selling the news".

The 'sell in May' calls that are trotted out annually have also multiplied this week. I have been looking for a reason to issue a 'sell everything' call as well. Although it is getting closer, I don't have it yet. In a highly integrated global world, the desynchronized nature of the recovery is, perversely, prolonging the risk-on rally by artificially limiting the bond market's reaction function to the recovery. That has generated a positive capital flow into U.S. Treasuries, despite the strength of the economic rebound in the issuing nation. Borrowing intentions are at record levels, but undeterred, demand at recent auctions has remained firm. The Fed is still in control of the curve. A disorderly bond market was my biggest fear. I don't see one now.

Similarly, the volatility gauges have remained quiescent recently, as bullish investors complacently survey positive surprises on the U.S. domestic vaccine roll-out and a strong earnings season. Add to that, is the sustained rally in commodities, notably agriculture and base metals. These real-world fact checks have been decidedly positive for risk-taking. But it is the shape of the yield curve that has my attention. It is signaling a continued sideways pause as the most likely outcome. In times of market uncertainty, I always rely on my favourite saying to help provide clarity on markets. Stocks are a monetary phenomenon. And the monetary backdrop is still bullish.

The yield curve steepening has treaded water lately, as seen in the chart below. The risk to equities from a hyper-competitive bond market is unlikely until this measure fully rises to the 2.5X level in my view. The recent short-term pause in yields is salubrious. ( sorry - I love that word and don't get to use it often)

All in all, the markets are likely to be boring and choppy for a while longer. It's no surprise to me that when the market outperformed the economy last year, that the obverse is now the case. All the surprising data in the world wouldn't make me run out to add risk right now. But there is no panic either. A stalemate for the broad averages. This week we seem to be heading a bit lower, but by next week who knows?

Rotation has masked the internal correction for the broad averages. Many of the favourite momentum trades from last year have been sideways for months now. Tesla and the WFH stocks have been unprofitable trades for months now. Apple reported an earnings number that was the equivalent of a small nation's GDP, and the market promptly sold it down. Conversely, Exxon is the stock to watch now. As Brian Belski just said on Bloomberg, we have a 'market of stocks, not a stock market". Agreed.

The last speculative trade that has yet to break is crypto. Bitcoin hasn't made sustained progress now for more than 10 weeks. I'm calling an "Elon Musk hosts SNL" top for this segment of the risk spectrum. These digital tulips are soon to head back to the Doge-house.

Risk Model: 3/5 - Risk On

One less positive this week as AAII Sentiment has dipped from the highly elevated levels that accompanied the April rally of everything. The rise in Volatility is noticeable and will bear watching as the signal line is in decline towards the recently rising measurement. Patience will be required this month and any abrupt move should serve to create a knee-jerk but buyable low-risk entry point.