Toss up

That rumble in your stomach isn't indigestion. It's the uncertain feeling you get when the future isn't clear. We have been tossing the news salad over the past few weeks, and it is anybody's guess what happens next. The markets are trying to position themselves for any outcome. I'm calling it 'narrative nausea'. We are sick of the news!

The status quo with a Democratic president and a divided Congress is the slight betting favourite. This would also come with a destabilizing 'Stop the Steal 2.0' and possibly delayed transition to the new regime. But it would ultimately bring stability and a bond rally that could propel markets to new highs.

A Trump victory would bring a knee-jerk sell-off in fixed income due to tariff/inflation concerns. I contend that stocks would suffer from a risk-off decline due to a too-narrow valuation premium to bond yields. But this would be temporary, as the worst-case scenario is rarely the final outcome. Promises are not policy. Again, in this scenario, bonds should bounce.

Meanwhile, in the financial markets, there has been a huge amount of hedging. Yields have backed up 70 basis points, and stocks have drifted slightly lower. Sideline cash has built up, and bullish sentiment has ebbed.

Does any of this matter in the long run? Is there too much of a term premium built into the 10 yr? Is there a wall of cash ready to buy the dip? Was my call of caution last week a bit of 'Chicken Little' thinking? Probably. But you can't blame me for being a bit sick to my stomach, given the political discourse's bizarre nature.

The Fed's decision this week is also a toss-up. Their job has been made more difficult due to the recent volatility in the data. Conflicting jobs data has clouded their thinking. But a 2-3% economy with 2-3% inflation expectations means a rate decision that cuts more than expected is unlikely. The yield curve has already normalized, and financial conditions have responded positively. Powell & Co. are almost a non-factor. It's earnings that will provide the upside now.

Good news! The fever will soon break. Certainty will soon replace uncertainty. It's a bit like the 'guns at the border' analogy I often bring up. When the buildup to something creates maximum uncertainty, as in the 1990 Kuwait war prelude, the time to be bullish is usually at hand; markets rally on the first shot and don't often look back.

And that's no toss-up.

Risk Model: 2/5 - Risk Off

Now that the stock market's overbought condition has been worked off, the AAII, VXV, and Cu/Au indicators are incumbent on providing the buy signal. Given that they are all linked to the election outcome, one or all of them could turn quickly. As I said above, they are all saying the same thing—"I need to hedge some tail risk." This is the bullish backdrop I'm seeing for a post-election rally.

AAII Sentiment is stuck at the bottom of a volatile range. No wonder people are confused this year!

AAII Sentiment Ratio

Short-term fears are at an extreme. I'm showing the inverse of this relationship here (VXV/VIX). Short-term protection is very expensive relative to the 3-month equivalent. This is usually associated with market bottoms.

Implied Volatility - VXV vs VIX

China's efforts to support its stock market and economy are getting all the press in the metals markets, but some scepticism remains. Global growth outside of China will matter as much going forward as many emerging economies join the growth party. Meanwhile, a looming supply deficit in the back half of the 2020s is being built. A breakout to significantly higher levels in the back half of the decade is becoming increasingly likely.

Copper/Gold Ratio, $SSEC China Stock Market

Gold, now pushing to all-time highs, has gained favour as a hedge against the growing moral hazard of profligate monetary and fiscal conditions globally, and rightfully so. But it is a bit of a popular trade now. Notwithstanding declining Covid inflation effects, the case for hard assets has not been this strong since the late 70's, given the populist dominance of many of the world's governments. Copper ultimately benefits as much from global central bankers' now more relaxed monetary stance as gold. I think copper can outperform gold once the effects of that reflation surface mid-next year. Seasonality is perfect here.

Sell Gold to buy Copper here. But both should ultimately outperform fixed income. FCX should do nicely after successfully testing support.

Copper Seasonality

Freeport- McMoRan Inc.