Newton's Dilemma

The widely quoted myth that Issac Newton suddenly 'discovered' gravity after being struck by a falling apple is most hype, or as we now know it - "Fake News". Later in life Newton often liked to tell the apple story as a tangible way of popularizing the discovery, but the event probably never took place. It took more evidence and contemplation, rather than a singular eureka moment, to come up with enough confidence for Sir Issac to propound such an important conclusion.

As we enter a possible 'correction' in the overbought market, we are similarly faced with a falling AAPL. And, as was Newton, we are faced with arriving at a conclusion with very little evidence. So far, Apple is the only leadership tech stock that has significantly weakened into its upcoming earnings report. There has been no corroborating weakness in any of the other FANG partners; with GOOGL and FB at new highs and NFLX making a $60 power move. AMZN targets are in the $1800 range now.

Apple has actually been downgraded by a few heretical analysts recently as the unimpressive "supercycle" of upgrades is failing to excite their "core" shareholder base. This morning's WSJ is reporting that iPhone X production is being slashed due to weaker than expected demand. Anecdotally, the new phone is overpriced and, as with most new generations, subject to complaints. My two millennial nieces can wake each others' phones up simply by exchanging their glasses - and they're not twins! Can't they get rid of the annoying 'notch'? And really, is the best new feature of the iPhone X applying animated dog ears to my Snapchat videos? I just upgraded the battery on my old iPhone 6-Plus.

But Apple looks to be a one-off. There isn't much other evidence for a trade-able correction. S&P earnings revisions have been at record levels, the upward guidance is strong, the valuation lift has been an appropriate re-rating, post U.S. tax reform. The bond market's yield back-up, although sharp, is coming from such a low level that it is unlikely to threaten equity's relative valuation until there is a solid 3 handle for the 10yr.

Although sentiment is overly ebullient and momentum stretched, fund inflows are strong. The economic data reports this week seem unthreatening, as yesterday's tame employment cost index showed, coming in bang-on consensus. No inflation threat yet. As I said last week, we will have to wait till March when we lap easy 'comps' for a real inflation scare. The bond yield back-up story is now a consensus trade.

This is the perfect environment for 'Tuesday at 11' to work its magic. The rumblings of a correction have been heard since last Friday. People have had a few days to adjust their portfolios. The market, if it is to shake off the mini-correction should bottom today. We are already seeing a stabilization this morning after the first hour selling abates.

Tonight's SOTU message should see Trump following the script rather than quoting his Twitter feed and the shameless cheerleading will be laid on pretty thick. Investors, late tonight should be going to bed with bullish dreams of infrastructure sugarplums in their heads. Month end bounces are typical in bull markets.

I'm closing out my shorts, buying the dip in EEM and selling my VIX ETN today. I may even take a bite out an AAPL on the earnings report later this week.

Still, I do have to admit to being ready to turn on a dime and become a seller again, as the acceptance phase of a rising market is creating a dangerous sentiment bubble. In the past two weeks, I have received two unsolicited questions from non-equity market savvy friends that unnerved me. They wanted to buy Bitcoin and Cannabis stocks. If I get my next cab driver tells me to buy Lithium, I'm outta here!

The last few days looks like a warning shot that we could be vulnerable to a playable down move soon.

But it will take more than one 'falling apple' episode to convince me that the market will correct just yet.

Risk Model: 4/5 - Risk On

An elevated VIX reading is all that stands between us and a fully bullish reading. The recent sideways move in the XIU has corrected the elevated RSI momentum reading to a buy zone. The recent underperformance of the Canadian market is notable against history. The current discounted valuation to the U.S. market while understandable fundamentally, is a comforting sign that we have room to run. I've been waiting to 'beta-up' in Canada with commodity and cyclical plays but am held back by overbought and "crowded long" oil market (see below). Speculative positions are at a all-time high. The budding roll-over in crude this week should continue and present a better buying opportunity (mid $50s range) in the next few weeks as the seasonal weakness unfolds.

WTI Speculative Positions