RIP, Buy the Dip

In a Pavlovian response to the sudden easing of financial conditions (mostly from bond yields collapsing) stocks tried digging in their heels today. The TINA buyers, who now see an S&P 500 yield above 30 year bonds, were mechanistically deploying cash on the open into an asset class that notionally provides superior income generation with no thought to the sustainability of those dividends.

U.S. equities are dangerously reflecting a degree of immunity to the effects of global growth weakness on U.S corporate profits that may not exist.

A high level of complacency is evident in this morning's action. The dip buyers were out in force this morning. Bullish investors aren't even waiting till Tuesday at 11 to nibble at stocks!

The Fed is now backed into a corner by market expectations that have raced ahead of the hamstrung policymakers. If they don't cut rates by 50+ basis points as implied in the futures markets, the market will react in a fashion that mirrors the December 2018 collapse. It is this power struggle between the risk asset market and the Fed policy that I worry about most.

The Fed is "closely monitoring" the economic impacts of the Coronavirus but so far it is unlikely to move rates preemptively. Stocks are setting up a Catch 22 scenario by trying to rally so soon after a short sharp decline.

Perversely, any such stability in markets will cause the Fed to sit on its hands for longer. With the front end of the curve inverted, all-time highs in valuation, and a black hole earnings path staring the market in the face, stock prices are pissing into a wind like never before.

It is increasingly evident that the bull market; one built on lower for longer rates, is not yet ready to quit. But it is on borrowed time - literally. The positives from a 'Fed Put' mentality may soon be overwhelmed by a global slowdown that continues to deteriorate. Inflows into credit and equities from passive investors have been strengthening recently but this week may see that change.

Should the news worsen on the virus front, the Fed will need to react. But stocks will face a damaging earnings hit first- one that isn't priced in. Conversely, should the news become more constructive, a sharp back-up in long rates will snuff out the TINA bid for the market leaders. Either way the markets look choppily lower over the next six months.

The liquidity driven bull market is still alive and well. But it is in its last stages, as the effects of lower rates produce ever diminishing positive economic effects. The supply shock dynamic of the Coronavirus is something that the Fed is unprepared to deal with. I'm betting we need more bad news to prompt the Fed to move rates lower. The risk that the market negatively reacts to a "behind the curve" Fed is rising sharply.

The positive correlation between yields and stock prices that was re-established last year is still ongoing. As measured by the relative performance of the average stock (RSP), versus the bond market (chart below), a negative countertrend move in stocks versus bonds has been in place since the Fed pivot to easing bias in late 2018. I see that persisting at least until the global economy is back on track late this year.

Equal Weight S&P 500 vs TLT - 30wk ma

So "bond-like" equities, Utilities, Real Estate and Quality are still in leadership mode. But most of this highly bifurcated market is underperforming bonds. Growth over Value is still alive and well. Trouble is, the market is vulnerable to a supply shock recession. The Fed can only affect demand. Fifty basis points may be no match for a negative GDP print from China.

So with bonds you get all positives of lower rates without the earnings vulnerability. No wonder they are at record low yields. As much as I hate to say it the Bondies have it right now.

For stock players, forget 'Buy the Dip'.

Its 'Sell the RIP'.

'Rest In Peace' - out of the market.

Risk Model: 2/5 - Risk Off

The AAII survey this week will likely fail to confirm a buy signal from the risk model but we need to see the data first.

The Copper/Gold ratio has been blown out of the water, testing the lows set during the Great Recession in 2009. The 3 month VXV is elevated but has room to expand further to mirror the 2018 melt-down.

A test of the 200 dma is still some distance away. but the drop to the 50 dma has been sharp, causing a sell signal from the RSI component of the model.

Ugh!