Rotation Nation

Yesterday's talking head topic-du-jour was the 'rotation' that took hold of the U.S. market last week. The long suffering 'Value' investors, who have been banished to 'Investor Siberia' since the financial crisis, are starting to jump on the bandwagon in another attempt to wrest the mantle of market leadership from the Momentum/Growth adherents. Is this just another head-fake like the one last seen after Trump's election victory in 2017, or something more durable at hand?

As we see in the relative performance chart of the Russell Growth and Value ETFs below, Growth's performance is quite stretched - especially over the last 18 months. Since the beginning of the current cycle, Tech stocks have been dominant due to the slow growth, low interest rate environment. But now a 'mean-reversion' correction in this relationship is developing. Facebook's earning's warning and lowered guidance has now set the tone for the pull-back in the momentum trade.

Russell Growth vs Value ETFs - Relative Performance

But mean reversion is not the same thing as a leadership change. Just like the currency market, a 'relative' relationship, like the one shown above, needs to be analyzed from both sides. Just because the Growth trade from its over-bought extreme, doesn't mean that Value stocks will rise in absolute terms.

The catalyst for a durable rotation and a rising trend in Value is not yet present. At least not yet. Also, its no coincidence that this is occurring in July, usually a time of profit-taking in the first half winners.

The Copper market, grovelling at a one year low, is certainly not supportive of a commodity cyclical rotation. Oil is levitating on short term supply concerns but has not convinced me that this strength is anything but a residual of the huge wave of speculative interest from earlier this year that has yet to wash out. I'll say it again - there is plenty of $70 oil to go around.

The value-rich Financials need a rising yield environment to make me a believer. The yield curve has steepened modestly, but the 10Yr bond yield is stubbornly stuck below 3%, as perennially timid retail investors continue to put money into defensive income funds and yield starved foreign flows continue unabated.

So the jury is still out. I need to see some corroboration in the form of a bearishly steepening yield curve and a Copper/Gold ratio rally. A turn in the emerging markets (EEM-N) would help support the argument as well. (That chart is starting to stabilize after a steep correction)

Everything could change on a dime, should the cyclical data start to improve. China has begun to add liquidity and fiscal stimulus. European data are oversold and due for a bounce. Trade rhetoric has been stifled with the Junker/Trump truce and rumblings of China talks. Currencies have cheapened against the Greenback, further easing global monetary conditions. The pump is primed.

Additionally, Trump's end game of creating boast-able deals from his trade gambit might actually work. A bilateral Mexico deal now looks likely, but, for now, the market is sceptically keeping its head down. But we didn't expect tax reform to get passed either. There could actually be method to the madness coming from Trumpland.

Remember! Short and sharp corrections are the hallmark of bull markets.

We are set up for a Tuesday at 11 counter-trend rally in tech, as the weekend headlines blared "sell - sell - sell". I will be waiting to see the quality (breadth and volume) of this bounce.

Before passing judgement on a durable leadership rotation, I also need to see some more evidence. The key level for me is 3. Copper and the 10Yr need to get above that level for any rotation to take hold.

I'm heading to the driving range today to work on my rotation - the only one I care about right now.

Risk Model: 3/5 - Risk On

Looks like the model has stayed bullish, despite the de-FAANG-ing of the market. The RSI, 200Dma, and importantly the 3mo VXV (smoothed VIX) have stayed the course.

This past week's sell-off in the tech sector has not bled through to the broader market. Encouraging!

The weakness in AAII sentiment continues, setting up a 'risk-on' reversal on any perceived good' news from either Trump or the Fed.

The deeper cyclicals are mired in the crosshairs of a potential trade war and a modest global growth deceleration. The Copper/Gold ratio is reflecting this harsh reality.

Should the Fed signal a pause in their rate hikes, thereby weakening the U.S. dollar, a commodity based rally could ensue. Not holding my breath though. Show me.