When Doves Cry

At what point does a song become 'Classic' Rock?

Prince has been gone for 5 years now and his breakthrough hit from 1984 comes to mind. He defined the sound of the eighties, giving popular music the soundtrack to the post-punk era. Along with Madonna, he emphasized a techno-beat synth-sound that was both energetic and catchy. And fans loved it.

Not everyone bought into the regime change, however. There were plenty of Boomers who continued to cling to the 'Classic Rock' security blanket, resisting moving with the times. Hugging the memories of the late sixties and seventies, they craved a more organic sound with real drums, dimed tube amps, and non auto-tuned vocals. Many still do, judging by how Q107 has managed to keep the same playlist for 30 years.

Similarly, investors are being split into widely divergent camps when it comes to their approach to the markets of today. The 'Classic' group of investors are hypersensitive to issues like debt accumulation and inflation expectations. Conditioned by the experience of the '70s, they fear a return to runaway price and wage spirals that will create market chaos. They rail against the Fed's dovish policies that are seen as promoting excessive risk-taking. The boom in Bitcoin and meme stocks like GME seemed to support their view. The inflation scare of recent weeks reflexively caused a bout of selling last week. The AAII survey (Boomer sentiment) has sharply retreated this month.

The more nuanced view of the near-term future, as with the music of Prince, is far more complex and difficult to assess. But it is, on balance, positive for financial assets. The U.S. economy is printing numbers that scream 'boom', yet bond yield back-up has gone bust. Whether it is the dovish messaging from the Fed, the global savings glut, or the realization that current inflation rates are indeed transitory, fixed income investors are still pricing their market firmly in negative real yield territory - a huge support for risk assets.

'Big Tech' is now entering the financial services business in a big way. Apple-pay, Shop Pay, and many other digital payment systems are competing for consumer transactions, effectively digitizing their wallets and creating a monetary system separate from the traditional banking system. Square Inc has linked its payment system to its rewards-based cash app in an effort to capture the consumer in a financial ecosystem controlled from start to finish. These developments are, in my view, highly dis-inflationary. Bringing down the costs of transactions, as we saw with the collapse of stock trading commissions, will benefit the economy at the expense of the traditional banking system. Fintech is a bullish tailwind for markets.

Perversely, the sudden flash-crash in the crypto markets last week is, in my view, a bullish indicator. Excessive risk-taking is financially destabilizing and brings with it the threat of tighter monetary policies. Releasing the pressure valve on a frothy market, while painful if you are a leveraged player, will ultimately prolong the broader financial bull market. The stock markets saw a decent amount of outflows last week but withstood the selling just fine.

The sudden deflation of Bitcoin will mark a turning point for the markets in other ways. The 'gamification of stock investing, exemplified by the Reddit/Robinhood investment mania, will fade from view, eventually to be replaced by a welcome rational and chastened participation from the newly-minted, and increasingly important, retail crowd. Welcome to my world Prince fans.

The rush into commodities, while longer-term fundamentally justified, exacerbated the inflationary phobia. That seems to be sorting itself out as China leans against the recent surge in both digital and physical commodities. The suddenness of the demand restart is a non-repeatable influence on commodity prices and supply responses will, with a lag, temper the rallies. Lumber price behavior - down $500/mbf from the peak at one point last week - is the template example.

The 'sell in May' crowd is now sidelined, having been scared off by the noise-makers in talking-head land. The cash built up by that liquidation event will eventually come back to the market later this year. Implied volatilities in bond, currency, and stock markets have subsided as quickly as they spiked. Meanwhile, earnings have sufficiently back-filled valuations in all but the most speculative stocks and the markets are dealing with those outliers one-by-one. The binary trade of earlier this year of 'growth to value' is looking more random than before, but generally should hold up well. Choppy, mostly sideways markets should persist throughout the summer but periods of volatility cannot be ruled out. Meantime, buy Ford, sell Tesla! It is still a market of stocks, not a unitary risk on/off wind vane.

And it should remain so until the Fed doves start to cry .... "taper".

Risk Model: 1/5 - Risk Off

An overbought market that refuses to sell off materially continues to frustrate macro-driven strategies. Although the sentiment indicator, AAII Bull/Bear ratio pulled back sharply this month, the rotational, stock-specific dynamics of this market have been powerful offsets. The Copper/Gold ratio has given a mechanical sell signal, reflecting the cresting of an overbought copper market, combined with a catch-up rally in Boomer Bitcoin - gold. Commodity bulls take note.

We should be at the point where markets similarly de-trend into a sideways chop. Although the fundamentals are supportive, many technical factors have started to wane. Stocks above the 50 moving average, Chaiken money flows, MACD &PPO Momentum readings are all losing steam badly.

Markets are now in a vulnerable state and some degree of caution is warranted. Maybe "sell in May and go away" will be supplanted by "sell in June and wait for a swoon"