Where Do We Go Now?

The bottom is in. But so is the top. Now what?

The correction that resulted from the Fed's revised focus has quickly, and in some cases viciously, run its course. A beachhead has been captured in the war on inflation. But the heavy slogging to ultimate financial victory has just begun. Tricky market action is the new normal in 2022.

The Fed's "transitory" has been replaced by "targeted" and that's a good thing. They are now poised to deliver enough rate hikes to quell the nascent inflation expectations that threatened to get out of hand had Powell & Co. continued to dither. But talk is cheap. The markets need to see some live fire before regaining confidence in a Goldilocks outcome. A hard landing is still a nagging possibility. The lingering pandemic and a stuttering global impulse from both China and Europe are creating increasing fears of a slow-down. Tightening into weakness in 2018 didn't end well, and those memories are fresh with investors.

Was the correction sufficient to 'price in' those fears? If one looks at the "market" you wouldn't know. The 1-month decline for the S&P 500 was 5.3%, the QQQ's was 9% and for the oil/bank heavy TSX, it was less than 1%. So it depends on which market you are talking about.

Forget the 'market'. What we have now is a market of stocks instead of a stock market. The Fed's perceived hawkish turn has seen to that. I say 'perceived' because it is so far from a tight policy as to be laughable. They not only kept their current QE projections but their punting of QT and balance sheet reduction keeps that elephant in the far corner of the room. Clearly though, their ending of easy policy has ended the era of TINA and Buy The Dip.

R.I.P Robinhood Hodlers.

The divergences in January were notable. The "Heat Map' depicted below shows how the different S&P 500 stocks performed for the month, as well as their weight in the index, as reflected in the size of the box. Despite huge areas of red, you can see pockets of green emanating from Energy and Financials. But given the sheer size of the Semis, Software, and Consumer Cyclicals, the broader market gave the appearance of an emerging bear phase. But I dismiss that notion explicitly. If this is the beginning of a bear market - there would be no prisoners. The rotation of internal performance saved the 'market'.

S&P 500 HEAT MAP

Now that the bottom is in, Axl Rose's words, nasally intoned as they were, take on new meaning. Like a good economist, I always fall back on 'it depends'. Many worries persist. Ukraine - I think we can solve this but what confidence do I have? China - a Zero-Covid policy and a Real Estate collapse? Oil price spike - not a recipe for strong consumer spending ex-energy. Labour shortages - not corporate profit friendly. But we always need a wall of worry to climb.

Get used to these uncertainties and possibly many more like them this year. Remember, this is a year in which the economy will do better than the 'market' - but it doesn't mean selling everything and going away. There will be trades aplenty. Finding your way through this maze of choppy price action takes nerves of steel. And the younger money managers among us don't have the muscle memory to fall back on to navigate this type of market, but they will learn quickly. In this type of market, risky traders will soon be driving Lambos while cautious PMs will still be taking the Go Train.

Short-term, the most probable outcome is a sharp bounce in the most deeply oversold segments in Tech and Consumer Cyclicals, as well as the ARKK theme stocks. You can thank the tepid action of the long end of the yield curve for that. The calls for 2%+ ten-year yields are now fading in the face of the persistent flight to safety bid and recessionary fears. For some, the clear message of bonds - an inflation peak in 2022 and a return to slower trend growth in 2023 is a siren song that still entices. I have to admit that I still listen to those same sirens songs on my personal financial Spotify as well - Neil Young be damned.

Now that the froth has been blown off and the perma-bears have been trotted out, the risk-on urges in my gut have kicked into high gear. As a contrarian, this past month has ticked all the boxes for a sentiment-centric, non-fundamental, garden-variety correction. The real bear market looms a bit closer but for that, I await a Fed that gets 'ahead of the curve'. With Fed funds at 25bps and a 65 bp steep yield curve, they have a long way to go. A clearly articulated Fed pivot to the removal of outsized accommodation is not a policy error. On the contrary, a rotational soft-landed equity market combined with a calm credit market represents a Fed policy success. Sorry, Jeremy Grantham and David Rosenberg, move along, there's nothing to see here.

So there you have my market outlook, choppy, range-bound as it is. Sorry if it makes your life difficult. But get over it, Sweet Child O' Mine.

Risk Model: 2/5 - Risk Off

The slow-moving model will have a tough time keeping up with this market. It is quite likely that the model this year will provide more 'shoot-where-the-rabbit-was' moves than usual. It works better in trending markets as we have seen over the last ten years. If the VIX and VXV keep falling after last week's buy signal, (VIV-VXV briefly inverted), the slower moving model will generate a buy signal this week. I bought $SHOP last week in a bit of a javelin-catching move but it could be gone soon. Trade 'em if you got 'em.

A retest of the lows or a new low is unlikely given the extended CBOE index options skew readings that matched previous low-risk entry points. Note how the 12 wk ROC of SKEW has coincided with previous market bottoms. This tells me that people were prepared for the sell-off and have still have ample cash to deploy.

CBOE SKEW