Fed Rx

Dr Fedgood & the Governors

Chairman Jerome Powell, the leading candidate for hedge fund manager of the year, has bailed out the market once again. Yesterday's announcement of their intention to directly purchase individual high-yield debt securities has removed all doubt they were serious about righting the liquidity ship. His prognosis of the Covid economy in last week's presser was depressingly negative. It stands to reason that his prescription to doctor the economy back to health would include extraordinary measures such as direct buying of junk bonds. The market seems to like this new drug he's prescribed - HYGroxychloroquine.

Some may question the timing of this preemptive strike on a correction that had began last Thursday. Despite the surprising strength of the May 'restart' economic data, he still felt it necessary to act, seemingly to show he was gonna walk the walk, not just talk the talk. Nipping the equity market correction in the bud, he has revealed a willingness to lend and lend freely, asset bubble be damned.

So we are left to trade the market we have, not the market we want.

Last week, I postulated a pause in the equity rally - one that had gotten frothy around the edges. I also thought it would be tough to trade from the short side, given the big unknown - the Fed. Now that we have been given another 'get out of risk-jail free' card, it's time to go long again. Already?? Yes sports fans, it's the short and sharp corrections that are hardest to play. They are the hallmark of bull markets from my experience.

The quality/growth trade took hold of the market to some degree yesterday, but the banks and select industrials did well too. It was a broad-based rally, with only Health Care and Energy noticeably lagging. I still hate energy stocks, by the way. The recent collapse has driven down the long-run average cost curve - there's lots of $35 oil!

As we transition from Covid shut-down to a tentative restart and the data gets 'less bad', markets can continue higher on optimism alone. The time to get concerned is either, a blow-off rally that sucks in the recalcitrants, or the data get so much better that the Fed reverses course and tapers the stimulus IV drip. Meanwhile we can keep partying like it's 1999 with Dr Fedgood and his Motlëy Crüe of governors as drug pushers.

When is it time to worry? Technically, the market will tell us.

Remember in March when I showed the chart of the % of stocks above their 200 dma? It's time to revisit that indicator.

% NYSE Stocks > 200DMA

Two things stand out. The 2009 and 2020 bottom are similar as to the bombed out lows - around 2.5%. Note the subsequent recovery to over 75% in 2009, a move which included the financials despite their much weaker fundamental story back then.

The second interesting factor is the descending level of highs for the indicator over the past few years. I would assume that, given the economic damage of the virus shut-down, the market recovery will struggle to include a new high for this indicator. I will start to get more nervous at any reading above the 65% level. All it may take is a rotation to the 'leftovers' to achieve this. Financials would be the prime candidate.

The recent sharp pull-back in these laggards was a function of a flatter yield curve. After the Powell reset, it is set-up for another up-move on the back of a stimulative re-steepening. Shown below, the XLF has some unfinished business to get back to the 200 day line. This could coincide with a quarter-end rally where investors chase performance.

XLF

With the market now fully freed from any valuation constraint by a unfettered Fed, who knows how high it goes? The upward capitulation phase is here. Trade with tight stops my friends, the downside will be ugly when it comes. The Fed has prescribed enough drugs for now, but the withdrawal symptoms are gonna be painful when they come.

Risk Model: 3/5 - Risk On

The sentiment from the AAII crowd has again failed to kick in. Perhaps this will come from the soothing words from the Fed Chairman today. perhaps from better data. Meanwhile the sharp spike in VXV seems temporary and the Copper/Gold model is solidly in the green. RSI has pulled back and the 200 dma is not a problem yet.

ooo