Naughty & Nice

As in years past, I am taking time at Christmas to review my past year's performance and this year is no different. I'm happy to report the news is good. Financially, 2019 was a banner year for the major calls from your humble blogger.

After being bearish on the market in the fall of 2018, I came into the year in a cautious but optimistic mood. I issued a special note on December 21 you hopefully read. I called for readers to bottom fish the market. The Christmas Eve risk purge marked an important turning point for negativity surrounding Fed policy, and markets haven't looked back since.

I pushed back on the notion of rising rates, as Increasingly economic deceleration soon became the default scenario. Trade and Brexit concerns battered sentiment, keeping the bid on safe and defensive assets.

The Risk Model had a great year. It objectively called most of the turns in the market as shown below (the up and down arrows correspond to 'risk on', 'risk off'). It was a bit late in confirming the December bottom, but I was already long by then having bought heavily during the mid December collapse. A series of whipsaw moves ensued during the May-September period during the height of the Trump tariff tweets. This was followed by a definitive 'risk on' call in October. Nice indeed.

On July 16 - "Bank Shot" I pointed to the potential of a steepening yield curve as evidence of a "soft landing" - a contrarian call given the spike in "recession" readings on Google Trends. A bit early but still nice!

My September 10 blog, "Gorilla Hill" laid out the blueprint for one final push to new highs. On the topic of the two biggest market negatives, Brexit and China Trade, I wrote:

"Just getting closure on the two issues alone should be enough to flip the second derivative of global growth to the positive sometime next year. I believe we have already passed an important point of capitulation for risk appetite from the sentiment standpoint."

Also Nice.

My October 22 blog entitled "Over the Valley" reconfirmed my thoughts about a final push to the market top that would see new highs in the market. Importantly I postulated a more balanced leadership than simply the Growth/Defensive segments. Since then, the market has broadened out to include Banks, Emerging Market and Cyclical Technology in its new high lists. Nice.

In the recent " Art of the Turn" - Nov 12 - I pointed out to those with un-risked cash, such Warren Buffet, that it was time to buy something cyclical. Boeing would be an obvious one.

I'm still waiting for that trigger to get pulled. That would be nice.

But not all was right with my various musings, especially when it came to the bond market. A furious 20% rally that culminated in a blow-off style capitulation in August was a huge missed call on my part.

Specific calls such as going long DBA (early), short NFLX (late) and an early call to get out of gold, were notable blunders. But in the easy money world of today, it's hard to make contrarian calls. I'm more of a macro guy anyway - stay in your lane Bobby. Naughty!

As to what next year holds, we will have to wait for the calendar to flip. I, for one, will not be unhappy to see it. Having lost some friends this past year, including one of my best pals, it has been a year to forget, non-financially speaking.

But I have consistently stayed cautiously optimistic on the market, mainly because of the monetary backdrop. Stocks are, always and everywhere, a monetary phenomenon. The existential threat we faced in 2008 still motivates central bankers to err on the side of caution- like it or not. The 'get out of jail free' cards are still being passed out to risk takers.

The lack of support from government fiscal policy and the cautious, buy-back prone corporate sector has dampened growth, inflation and financial volatility alike. Goldilocks is alive and well.

'Lower for longer', a phrase that is almost 10 years old, is still the dominant driver of the current financial construct. Central Bank buying has inflated safe asset valuation to dangerous levels. This should continue to support expanded risk taking next year, but time is running out on the debt-fueled asset bubble. TINA is still in charge for now.

Until such time as the current deflationary bias recedes, a rotation out of financial assets into hard assets will continue to be pushed off. We should live so long as to see that day. At that point, the Central Banks could turn hawkish, meaning investors will need to get out of the way. That call is still ahead of us.

But until good news (on the economy) becomes bad news (Fed policy), I'm staying long.

Its both naughty and nice to be a bull.

Risk Model: 4/5 - Risk On

Last week saw a pronounced blow-off in sentiment that has me a bit concerned. Anything over 2:1 signals exuberance and the rate of change since the August lows has been meteoric. If the market has a set back into the first part of January, I would not be surprised.

Similarly, volatility is compressed, signaling a mood of complacency surrounding risk taking. Above or below the 20 - 15 levels on the VXV (3 Month Volatilty) are rarely sustained for long. The recent dip to 14.85 may have been the low.

That being said, a build up of unrisked and defensive positions will need to be recycled into assets that have cyclicality. This will be a long, drawn out affair that could mark the topping out of the market cycle over many months. Just buying the "market" this coming year is unlikely to be the winning strategy. I continue to expect rotation moves to dominate in an increasingly heterogeneous market.

Enjoy the struggle up the last part of the Gorilla Hill of Risk. It has been a wild ride and it ain't over yet.