Life Alert

Most readers of this blog will remember the ad depicted above. The product, 'Life Alert', was popular in the pre-cellphone era as a way of automatically allowing frail seniors to call for help. It looks to me as if the value segments of the market could use a product like that now.

To make the value-rotation trade really fly, we need two things: rising inflation expectations and 'conservative' investor confidence.

Let's go to the charts.

Inflation expectations, while having steered away from a deflation scare in March, are currently quiescent. The ETF that tracks inflation protected bonds has been underperforming nominal fixed income equivalent for years.

Inflation ETF/Treasuries

And most importantly to stock selection, the 'natural' buyer of value equities, the older investor, is exhibiting a level of persistent caution that has no precedent. The chart below smooths out the weekly swings by showing the 30 week average of bullish/bearish sentiment over the last 8 years.

The AAII group, dominated as it is by retired seniors, has fallen and can't get up .

AAII Sentiment Bull/Bears

As I postulated last week, market sell-off was short and sharp, followed by a bounce:

"The upshot of all this should be a bounce trade, starting today. The lack of a meaningful signal from credit markets comforts me that this sharp correction is likely a 'shot across the bow' type sell-off. But it is only a trade, given the risks from an overvalued, narrow market. Value players will still need an abundance of patience." - Tuesat11, Sept 8, 2020.

Interestingly, the performance of the average stock held up better than popular growth favourites during the three day risk adjustment, aka 'the correction'. Credit markets correctly held firm, further confirmation that the pull-back was a narrow and healthy event. The fixed income rally was paltry at best, much to the consternation of the perma-bears who have been fighting a losing battle since the Fed signalled its unfettered support of risk markets.

Generationally low rates, combined with plentiful cash levels in portfolios, limited the flight to quality effect. Conservative investors, already defensive were already 'there'.

So this week's bounce should be 'risk-on' biased. Growth will beat Value. Tesla bottom fishers abound. Zoom lived up to its name. Apple investor day hype is widespread. It's what comes next that counts. Can the 'real' economy start to change the narrative of the market?

Despite the damaging effects of social distancing on consumer facing businesses like restaurants and airlines, there has been progress in the broader economy. The housing market and auto business are experiencing a traditional post-easing rally. The service economy is learning new ways of doing things, but they have largely re-opened.

The last ditch fiscal package being unveiled this morning (Tuesday at 11, no less!) may or may not get traction. Long lines at food banks in key swing states are starting to worry GOP senators. Democratic leaders are open to compromise. The entrenched views are starting fracture, crumbling in advance of the looming election. And there's always a possible post-election deal during the lame duck session for the market to focus on.

Global economic prospects got a boost from the positive data emanating from a key set of data out of China. Consumers are back buying there and the second wave effects of the pandemic seem to be isolated and sporadic.

Commodity prices, ex-oil, are in a rising mode, helped by supply outages caused from Covid prevention shut-downs. Iron ore is trading at a six year high, testament to seemingly insatiable demand from China. Lumber has soared. And does anybody realize that, since the March lows, Freeport McMoRan has beat the pants off the broad tech average? No surprise to me, copper is harder to find and produce than oil at current respective values and demand is holding up better.

FCX/XLK

Importantly, Gold has held in well, forming a bull flag pattern that is almost complete. In the upcoming Federal Reserve meeting, a dovish stance should be re-confirmed, helping the yellow metal by lowering real rate expectations and validating their perma-ease stance. The journey higher continues. I would cut and run on the gold trade should the yield curve steepen past recent highs, signalling a recovery in inflation fears.

Most people mistakenly believe gold responds to higher inflation. That is only true when the bond market allows those inflationary expectations to go unchecked by real rates above 2.5%. The chart below shows that when the yield curve is near zero the gold market enters a bull phase that in the past has lasted five+ years and resulted in prices at least tripling. Year 2025 and $3500 - $4000 an ounce!

This is the most interesting question in macro analysis today - will the enormous easy-money debt-fueled recovery from the pandemic eventually create an inflationary impulse wave of comparable proportions? Gold will tell us. I'm staying long for now.

Yield Curve & Gold

Real rates heading towards 2.5% in response to a stronger economy will create the next bear market, possibly sooner than we expect. With multiples/yields on risk assets at current extremes, it won't take much of a rise to punish the bulls. Since good news will be bad news at that point, I guess we should be cheerleading the widely expected Covid 'second wave'.

For me the glass is half-full - based mostly on the easy money backdrop. I wouldn't be chasing the popular, yet over-valued, mega-caps here. Nor would I go all-in on the deep value trade just yet - especially the financials. That latter group has secular challenges that just won't go away easily. Deflation has hit large cap financials hard. They still have more dirt to sweep under their loan-loss carpets before the year is out. Their market share and pricing power, whether it be in the transaction/advisory businesses or in loan/mortgage originations, is under siege.

The bottoming process currently playing out in the world economy is also putting a floor under many small business. I'm showing a chart of the relative performance of small cap stocks to large cap below. They are forming a base. The next opportunity for investors could well come from stocks that are under the radar and not subject to sudden liquidity seeking market purges, like we saw last week. It's a market of stocks, not a stock market.

So there are other things to buy as the market chops sideways over the next few weeks in a pre-election, post-mania tug of war. I just received a report on a small $2 stock that I own which shall remain nameless, lest I'm accused of hyping my position. The target is $3.75 based on a modest 5.5X EV/EBITDA.

Now that's an investment that I can get up for!

Russell 2000 / Russell 1000

Risk Model: 4/5 - Risk On

With only the recalcitrants who paid for an AAII membership raining on the parade, the Model is staying bullish. As I said above, Copper has signaled the resumption of an economic recovery after an uncharacteristic summer lull. The $VXV had a quick trip into risk-off territory but has quickly subsided. The RSI and 200 DMA signals are both benignly positive.

I'm watching actual fund flows for a sentiment 'tell' now. Data from ETF.com shows that SPY inflows were twice the QQQ outflows last week. It's maybe better to see what people do, not what they say!