A Little Patience

For those of us who have yearned for a correction in the market, these have been trying times. FOMO thinking has been a formidable adversary. Although the Shorts have been repeatedly encouraged by some minor sell-offs lately, nothing seems to stick to this teflon coated Bull Market. Every seemingly bearish development is shrugged off as a buying opportunity.

What can we say about a market that refuses to sell off? Why are the markets going up in the face of bad news? When will the madness stop?

It just takes a little patience.

The best way to win at a game of cards is to wait for the deck to move in your favour.

Investor Edward O Thorp, in his book "A Man for All Markets", describes his method for beating the house in Las Vegas as a waiting game. He bet only small amounts until he had a statistical advantage. Then he bet big - and almost always won.

This describes the current state of affairs in the U.S. stock market. It has had all the 'Face Cards' this year. Strong earnings growth, stimulative fiscal policy and until now, accommodative monetary policy have emboldened the equity crowd for 2 years now.

Unfortunately for the pollyanna bulls, the deck is starting to be stacked against the long side. Just look at where we are in equity risk premium terms. The ratio of S&P earnings yield to bond yields is depicted below. (chart courtesy Stifel)

The ratio is now threatening to reach the stretched danger zone of 1.5 standard deviations off trend.

S&P Equity Risk Premium 1951-2018

This level of disproportionate relative valuation has been the cause of trouble for equity investors in the past.

Most recently, the dot-com bubble sell-off resulted from the combination of tightening monetary conditions and high valuations , similar to the conditions we are now starting to experience.

Stock performance has been spectacular relative to bonds since the March 2009 bottom. That was the month when, "the only thing not priced in to the market is Martians landing with ray guns". The cards were all stacked in the risk takers hands with cheap valuations and accommodative policy.

Fast forward to today and things look a little different. A Grand Super Cycle of relative return has played out for the equity market versus bonds. We are currently in the "fifth of the fifth" Elliot Wave phase. I would say the deck is now stacked against risk takers.

Stock/Bond Relative Returns (SPY vs TLT)

As the next year unfolds, the tailwinds of accommodative policy and easy earnings comps will fade, introducing the risk of a valuation re-rating of stocks to bonds.

But for now the only thing not priced into this market is ....

You make up the finish.

My view is the Bears just need a little patience.

Risk Model: 4/5 - Risk On

The bounce in copper has finally put the Copper/Gold ratio into "risk on" territory.

With the RSI and 200 dma in neutral territory and the VIX subdued, a quarter end window dressing run is in the cards. Copper was due for a bounce. Draghi's comments yesterday supplied the spark for a currency reversal that has helped buoy hard asset prices.

I am not convinced it is sustainable.

The AAII Bull/Bear ratio has been getting whipsawed by headline induced angst all year. The relative market calm that has greeted the latest Trump tariff news is surprising to the Home Gamers, who are likely to shrug it off as the market has already done. We should see an improved sentiment reading this Thursday, but it is now a lagging and therefore a somewhat less useful component in the Model.