Over the Valley

Successful investing usually takes a bit of faith. If the risks are "priced in", the returns are likely positive. The expectations of the crowd are the key determinant for pricing of those risks.

Based on my reading of sentiment, I believe the risks of a hard landing are "priced in".The time is now to look over that valley. The clouds are now clearing and the future is looking brighter.

The ascendancy of the pessimistic view has run its course.

Last week, after our wonderful trip to the Berkshire Mountains for Canadian Thanksgiving (see above) , I must have fallen into a bit of a tryptophantic stupor. I wrote my blog after a long drive back and I think it showed. In last week's "Light Switch" missive, I dismissed the nascent rally as a jumping of the gun, only a short-covering rally.

Although a valid take on the factual events of the Trade/Brexit issues, it missed an important element. The all important 'expectations of others'.

If I have had one overriding fixation in my investment career it is an infatuation with sentiment. I doesn't matter to the market what I think should happen. It only matters, when trying to get the direction right, what others will think. "Anticipate the anticipations of others."

I believe that we have turned an important corner with respect to growth expectations. The preoccupation with the global slowdown that has paralyzed markets seems to have run its course. The "second derivative" of growth is due to go positive soon. (for the mathematically challenged, consult your old notes from Calculus 101)

A low in yields, punctuated with the massive suicide switch by most investors in September, has lead to a strong rally in the 2s-10s curve similar to what was seen in the 2016 soft landing (below). Last week we saw breakout moves in three important cyclical indicators; Homebuilders, Banks (led by JP Morgan and Morgan Stanley), and the all-important Copper/Gold ratio. Credit creation is alive and well despite the gloomy headlines to the contrary. After being given up for dead, inflation expectations are due to start rising shortly.

U.S. Treasury Yields: 10yr-2yr

This supports a pivot in the Value/Growth ratio. The successful test of September's reversal came last last week. The downtrend in this ratio created by the now-aborted monetary tightening of 2017-18, seems to be broken.

Value/Growth Ratio

Global positives now outweigh the negatives.

The credit markets are in decent shape. Employment levels are robust and incomes are still growing. The consumer is holding up the economy as it waits for the industrial deceleration to bottom out. Most importantly, a coordinated monetary stimulus from the central banks and stimulus initiatives from China have sufficiently cushioned the worst blows from the trade dispute. Additionally, seasonality is now working in our favour.

The slowdowns seen in the PMI indicators are not as threatening as they once were, given that the services component has held up reasonably well. The recession calls coming from the likes of the ERCI Institute (as well as my favorite contrary indicator David Rosenberg) have overemphasized the industrial segments of the economy in their bearish calls. With debt service costs hovering at decade lows, it will take a reversal of easy money to bring down the critically important consumer sector.

This doesn't mean I have full confidence in an instantly rosy growth forecast. The currently embryonic 'green shoots' environment I'm describing is fraught with risks, setbacks and false starts as we saw in 2009 and 2016. And we are not starting from ground zero from a valuation standpoint either - the powerful "TINA" bid has seen to that. But I am now predicting one more kick higher from this aging bull market.

I would recommend a quick reading of the Sept 10 issue of Tuesat11. I'm standing by the views expressed in that important piece. The evidence is building for a successful reflationary surge into 2020. The patience that I counselled hasn't cost me anything. The final summit, the Gorilla Hill, still awaits!

It is a bit leap of faith, but I'm willing now to look over the valley.

Risk Model: 5/5 - Risk On!!

The model says it all with a screaming "buy" signal.

With prices moving sideways for much of the past six months, there is now a firm base from which to build a rally. Bullish sentiment reached a capitulatory low two weeks ago. Volatility levels have subsided to comfortable levels and the Copper/Gold ratio is in gear above the 50 dma. What more can I ask?

Copper/Gold Ratio

Perhaps we pause here as the final acts play out on Brexit and China Trade. There are still wild cards in both dramas. I really don't care what the outcome of either of these issues is, just getting the uncertainties behind us should be enough to break the log-jam of economic inertia that has held growth back.

The reasons to be bullish are reflected in the adage "Don't fight the Fed" - especially when the Fed is easing. Equity strategists have been preemptively describing the extended market as "late cycle" for months now. But where was the back up in yields and rising inflationary expectation that usually comes with that scenario? M.I.A.

Should a global growth recovery, however mild it may be, create a "true" late cycle environment later next year, the Fed will turn hawkish . Only then will it be time to cut and run. But that's over the next hill. Enjoy the climb while it lasts.