Turn,Turn,Turn

As a long-forgotten poet once wrote, to everything there is a season, turn, turn, turn. Full marks to those of you who can guess the guy holding the banjo. Actually, he lifted most of the song from Ecclesiastes but public domain protected the royalties and the Byrds' record company made all the dough. So much for intellectual property rights!

As I reflect on a fantastic summer - the highlights being the healthy birth of my fourth grandchild and a spectacular voyage to Alaska - I am ready to do battle with Mr. Market once again. And before you start your eye-rolls, just hear me out - I'm still not charging for this. Netflix and Disney may be raising prices, but Tuesat11 is still the best bargain in town.

And so we must now turn our focus from a lazy summer to the prospect of a bit of volatility in the financial markets. Having survived a short and sharp correction, the bulls are back in charge. Economic cross-currents are everywhere, resulting in wildly divergent prognostications of the talking heads and blogging pundits. The data is mixed, with mostly a slight downward bias. Despite the cheerleading from the bears, this bad news is now good news. The FOMO crowd loves it. The bid to mega-cap tech won't go away easily.

The much hoped-for rotation I spoke about in June was hard to spot. The "no banks, no thanks" crowd (me included) got what they expected as deteriorating fundamentals kept them at bay. The post-earnings relief rally in Canadian banks has been notable but has only just lifted them from a capitulatory hole generated by the selling pressure from misinformed short sellers. But don't chase them here. Their fundamentals have still not turned the corner as NIMs, PCLs and Efficiency Ratios still haven't recovered from the BofC's monetary tightening.

Hard commodity players, hoping for a lift from an inflation surge, got no love either. China's real estate hard landing and a sharp slow-down in the Eurozone kept metals and other economically sensitive materials like lumber in the doldrums. Oil was a notable fish swimming upstream as supply curtailment and persistent demand kept the $WTIC chart in a bullish posture. This just demonstrates the differing elasticities of the commodity board. Despite all the ESG groupspeak and disinvestment, the oil stocks continued their bull market. Copper vs. oil shows the effect of a weaker goods economy globally on the more demand-sensitive elements of the commodity board. Gold isn't setting the world on fire either as it drifts below $2000 under the pressure of a stronger U.S. dollar.

Copper

Oil vs. Copper

Is oil's strength indicative of a burgeoning economic cycle? It's hard to be bullish on the economy with the Fed still holding the short rate structure at near-record inversion to the 10-year bond. That's why the default option in the stock market continues to be tech. Watch for fireworks on the highly touted $ARM IPO this week! Talk about too much money chasing too few stocks. With the IPO market shutdown, it's the only game in town, with an emphasis on the word 'game'.

That continues to confound those who see stocks as over-owned and overvalued. Try and tell that to those holding overweights in Small Cap, Value, and Emerging markets. The problem with talking about the "market" is that it is so completely distorted by megacaps that it seems frothy and overvalued. But taking that segment out results in fairly priced markets that are poised to recover. So what's the problem?

Real incomes and employment have hung in and there is still a lot of pent-up demand in housing. The economy is just waiting for any sniff of the Fed to lower policy rates. The inventory de-stocking has already occurred, leaving factories poised to ramp up. That should re-energize the left behind (left for dead) segments that have priced in a recession that may not occur without much tighter financial conditions. Should the soft landing continue to play out, the Fed will eventually be forced to step on the brakes again. That is not priced by the markets.

Base effects alone argue that inflation has already bottomed. I see trouble in the months ahead for the consensus of lower inflation. Even the Fed has forecasts of a declining front-end rate structure into next year. Yah, and the Leafs will win the cup too!

This out-of-consensus scenario results in a yield curve that may actually end up with long rates normalizing in a bear-steepening (read +5% long bonds) - a move that will eviscerate the crowded Growth trade later this year. The soft landing will eventually turn hard at that point, but that point isn't now. The only question left is whether there is still a soft landing 'play' in the value trade in the meantime. I think so. I have been watching for China to stabilize a bit and we are now getting close to the positive seasonality phase for commodities which has just kicked off by WTI.

Oil is an early harbinger of a soft landing rotation. The resilient U.S. economy is hard to shut down. Second-level inflation effects from higher labour costs are just now gaining steam. Bonds look vulnerable just as explosive issuance from Government and Fed QT loom as nascent threats. A 1% term premium on a 4% soft-landing inflation rate isn't gonna be pretty.

In the meantime, Dr. Copper, it's your turn, turn, turn.

Risk Model: 3/5 - Risk On

With a Goldilocks backdrop in the economy and FOMO in full swing, the markets are still in 'go' mode in my view.

The low volatility implied but the options market and widespread short covering are notable tailwinds. Sentiment pulled back sharply as a response to the equity weakness in August but could recover quickly on any sign of a Fed that is "done" for now. No credit market concerns are in sight. The commercial real estate headlines are fading as the WFH mania reverses course and workers slowly return to the city. The Regional Bank crisis has been successfully papered over by the Fed and bank deposit flight has ebbed. Homebuilder stocks just tested 2yr highs.

All in all, the risk-on trade has the upper hand until the Fed owns up to the reality of a persistent inflation problem that isn't going away anytime soon. By consistently underestimating the level of inflation since it reared up, they are still behind the curve but they either don't know it or don't care. That comes from a rearview mirror approach to policy and data dependency - aka ass-covering.

Remember this?