Mesmerized

History's ultimate example of medical trickery gave us a new word - "mesmerized". In the late 18th century, a charismatic young doctor became the toast of Paris with his elaborate treatments for common ailments. Franz Anton Mesmer was an expert at hypnotising unwitting patients - including the queen of France, Marie Antoinette - into the belief that his methods were miracle cures.

Similarly, the easy money policies of Fed Chair Jerome Powell have convinced many investors to deploy risk capital in an ever narrowing selection of assets that have perceived immunity from the worsening economy. First bonds, then pandemic-proof stocks and now gold. A possible rude awakening from this monetary hypnotic state is getting ever closer.

Having been mesmerized for weeks now, the stock market is facing the reality that the road back to normalcy is long and full of bumps. The 'bump-du-jour' this week is the predictably fraught blame-game in Washington over the extension of the fiscal benefits to unemployed and furloughed workers. But playing politics is what politicians do. You can't tell me you're surprised.

I'm now slightly short the market, hoping I'm wrong but expecting to profit from the impending hissy fit that is erupting in the most dysfunctional government since Julius Caesar's Rome.

Gold, propelled by a renewed wave of U.S. dollar liquidation, is signalling the duress of a monetary system gone wrong. Common wisdom, mostly created by the experiences of the 1970's, says gold prices are a function of inflation. That myopic view, one that reflects an era of demand excesses, is too narrow. Gold is also a beneficiary of systemic loss of confidence in a currency that is under threat of debasement from a deflationary economic collapse.

And current economic prospects have decidedly weakened, given the events of the last few weeks. It's one thing to put workers back in their cubicles or Pro Athletes back on the field (Florida Marlins excepted - but they haven't fielded a professional team in years). But asking mothers to take children back to school, without sufficient precautions in place, is quite another. And starving individual States of necessary school funding by a miserly Republican party won't help make them change their minds. This impasse promises to significantly blunt the economic rebound until the arrival of a vaccine against the pandemic.

Nor do I blame the Fed, given the intransigence of of their mandate to generate full employment and moderate inflation. But they have also created collateral damage to the financial stability of markets by the de facto abolition of risk. Speculation is now being generously rewarded and they know it. Past experience tells me the risk of a sudden reversal of this mass hysteria is now elevated. All it would take is a perceived hawkish phrase from Powell this week. Corporate earnings releases set to unfurl this week seem likely to be stale dated and downwardly skewed - also a reason for caution.

A sell-off would only be healthy, in the longer term, for markets. Check-backs occur occasionally even in normal times. Admittedly, there is a cushion on the downside from the huge cash positions that are ready to be unleashed from left-behind investors. In May, I postulated a fair value for the S&P of 2800 with a trading range of 2400 to 3200. This still seems like a good guide.

The recent crescendo of bullish calls for gold, especially off the back of a now hated U.S. dollar has the contrarian in me thinking - are the currencies of other countries that much more attractive? Gold is vulnerable to a reversal in the heavily shorted greenback. I concede that, with last week's fiscal package, the Euro has righted the ship in the near term. But the structural problems in the Eurozone won't go away easily. Domestic Institutional yen repatriation is helping the Japanese currency in the short term, but that economy is still moribund, taking a longer term view. And risk-on currencies like the Loonie and Aussie are way ahead of the economic rebound.

The mesmerized market, now drifting into the seasonally weak August - October timeframe, is vulnerable to snapping out of the complacent stupor created by an overly friendly Fed.

We need to get closer to the reality of a vaccine for risk-taking to be seen as anything other than a response to Powell's monetary hypnosis.

Risk Model: 3/5 - Risk On

Remember that the model is derived from the Canadian Market using XIUs as a proxy. The 200 dma rule is wildly different when looking at the NASDAQ. Despite the recent downdraft this growth biased index still sits 19% above that measure as opposed to the tame 3% reading for the XIU.

The RSI for the QQQs has dropped quickly into a comfort range around 55%. This, plus a benign VIX reading this week is holding the model back from issuing a sell signal.

I'm ready to cover my short quickly should I see a few things come around. This decidedly speculative 'short' call, going against the Model, is risky. But so was my "buy with both hands' call in late March that similarly ran ahead of the Model's output that was calling for "Risk Off".

I will reverse this 'short' call on any news that the fiscal band-aides coming out of Washington are more substantial and are to be issued promptly. For now, show me.