Zombie Bull

This market seems impossible to kill!

Last week, Fang stocks took back the spotlight in a show of earnings powered strength. Amazon blew away the shorts with a huge beat of the woefully pessimistic estimates. Apple is powering into its' earnings report and the iPhone X launch and Google, Facebook and Nvidia are at all-time highs.

Value and cyclical sectors once again took a backseat after a strong move. These previously lagging groups had shown a spurt of out-performance reflecting the improved global growth outlook. This morning's Chicago PMI print over 66, and the strong U.S. Q3 GDP over 3% means this pause should be temporary.

The continuing leadership ping-pong game that is playing out is truly impressive in the context of an epic bull market.

Inflows into ETFs and mutual funds are now the strongest all year. It would appear that Hallowe'en treats of strong data, good earnings and potential tax reform have motivated complacent investors to commit funds. Bears are now in full capitulation mode. I flagged this possibility in my earlier posts. When the FOMO gets the better of investors, the risk levels will be at their scariest. So what am I waiting to see that could derail this juggernaut market?

Financial markets are a purely monetary phenomenon. There is more market power in the hands of the Fed than all the Investors, CEOs, Finance Ministers and Treasury Secretaries in the entire world. Stocks prices increase at the pleasure of both the discount rate and the equity risk premium. Ultimately the Fed controls both.

As long as earnings expectations are increasing, as they are now, stocks can withstand a rising rate environment. Without earnings momentum however, a market becomes vulnerable to a hawkish Fed policy.

The 1987 crash, dot-com bubble, the great financial crisis, and the cyclical bear markets of 1980-81 and 1989-90 have had identifiable causes. In hindsight we can see what caused them. The Fed took away the punch bowl at a point where markets were vulnerable to valuation contraction or negative earnings momentum. This record setting bull will eventually succumb to these same issues , but not just yet. It seems likely that the new Fed chair will be announced this week. The preferred candidate now is Governor Powell, who should stay the course, keeping Fed policy rate comfortably "behind the curve", thus perpetuating the bull.

While uncomfortable with the widespread acceptance and complacency of this market, I am long, as per my model. I do, however, remember periods like this, especially in 1979, 1986 and 1998, that preceeded market tops. It becomes increasingly difficult to "stay with it" as markets got frothy and sentiment became ebullient. Bears are always right but early.

Breadth is starting to deteriorate, with notable earnings misses from the likes of GE, Under Armour, Celgene. Hence the increased attractiveness of active management.

We need to see the 'second derivative' of S&P 500 earnings expectations to go negative, combined with a flat or inverted curve to spark a correction or worse, a true bear market. As a best guess, I'm still sticking with a Q2, 2018 top.

Sorry bears, there is no Hallowe'en candy for you this year!

Canadian Dollar

As we postulated , (see 'After Burn' - Aug 22) the recent strength of the Canadian dollar was ephemeral. The Canadian economy is suffering from rising costs of production from the combination of minimum wage hikes, carbon taxes, out of control power prices. Add to that the inevitable NAFTA death spiral, and currency speculators are doing a quick rethink of the summer rally. As well, BOC Governor Poloz is making dovish retractions his take on the surprising, but transient data surge in Q2. The C$ spec positions became excessive and are currently being quickly unwound. Seasonality will be a negative influence until January. (see chart). Look for USDCAD to trade to $1.33.

USDCAD Seasonality

Risk Model: 4/5 - Risk On

The Kurdish supply threat has induced a surge in crude oil. This has propelled the XIU to an overbought level RSI above 70 on the back of the energy sector. All other risk model elements are in bull mode with the VIX briefly flashing a failed mid-week warning. Copper/Gold is pausing and I expect a short term consolidation of gains in the global cyclicals. Profit taking would be normal after such a strong run-up. AAII sentiment is unusually subdued, reflecting the perpetual scepticism that 2008 bred into the "Home Gamers".