It's Debatable

Alright America, time to decide which septuagenarian establishment white guy is best suited to lead you into an increasingly uncertain future. The first of three debates between Joe Biden and Donald Trump goes tonight. They've both been allowed to stay up past their bedtimes, so let the fireworks begin.

But like Trump's hair colour, there is a disconcerting tinge to it all. Does anybody think that the candidates now being presented to the U.S. populous actually represent a real choice?

Biden, with his wandering hands, is the goofy grampa, who everybody tolerates. Trump is the scary neighbour who yells 'get off my lawn' at your kids. Those are our only choices for the leader of the free world? Really?

The Democrats have proffered Sleepy Joe, a career politician and compromise choice between the radicals like AOC and Saunders, and moderate middle-class Democrats. Republicans are still reeling from the 2016 hostile takeover of their party by the swamp drainers led by "the Donald" and have been unable to pivot back to the center.

Trump's base is seemingly secure. His "Deplorables" continue to feel threatened at every turn in the racial/pandemic chaos wrought by 2020 and have continued to cling to his rhetorical bombast. Consequently, a polarizing ideological intransigence continues to be entrenched, much to the dismay of a younger demographic, yearning for real change.

The polls are showing the race to the White House is tilted towards Biden, but don't be fooled. I'm assuming Trump's numbers are underreported, as many a pollster found out in 2016. And because the quirky Electoral College has a permanent skew towards Republican-dominated swing States, it now remains to the undecided voter to tip the balance. Resultantly, tonight's debate has heightened import.

Nervous markets have now begun to exhibit increased implied volatility, reflecting the real fear of a contested election result. The continuing fiscal policy pissing contest in Washington doesn't comfort investors either. The previously held consensus around a Biden/Democratic sweep that helped propel markets during the August tech mini-bubble has now given way to a sobering uncertainty. And what do markets hate most? I'll give you a minute to think about it, but it starts with a 'u'.

The most widely telegraphed correction in history that has taken markets down this month, is running out of steam. As I postulated last week, a phase of choppiness has begun. Although FOMO has taken the month off, TINA still firmly in charge of the market dynamics. The bond market is highly unappetizing; not likely to generate flight-to-quality inflows from nervous stock players. Just as we saw in March, gold didn't cushion the blow either. The cashed-up, defensively positioned older investor, who missed the Robinhood rally, is again gingerly nibbling at stocks.

Unfortunately, I see no definitive signs of a leadership change in the latest market tape action. Yesterday's reversal was led by Tech and Growth. Value and Small Cap don't show any signs of investor love just yet. The yield curve has stalled in a holding pattern. The fourth-quarter growth expectations are increasingly being ratcheted down, implying bad things for the cyclical trade. Positive, but lagging, economic data due out shortly should mark a short-term peak for inflation expectations as markets for commodities have already weakened. Lumber after a strong rebound since the COVID-crash lows, by example, has dropped a quick 50% from the August supply squeeze peak. Oil looks seasonally weak now.

Bearish thoughts, previously ignored by the liquidity charged Growth rally players, have now begun to creep into the market narrative. Mohammed El-Erian yesterday voiced many investors' concerns that a delayed fiscal stimulus package and consequent deceleration of the economy are not priced into markets. Possibly, but those fears matter more to selection effects and not asset allocation. Yesterday saw both a bank rally and a tech bounce. The tech bounce was driven by the 'bad news is good news' buyers. The banks responded to pro-growth hopes generated by news of the latest fiscal package promoted by the Democrats. You can't have it both ways.

So saying "the market is higher" misses the point. The question is really about the leadership of the rally, which is not a forecastable event given the tight election prospects and renewed pandemic fears. It's now a debatable outcome.

But I reiterate what I said last week. The time to buy is when you don't want to. Now is that time. I just don't know if the next move higher will be as a result of a true cyclical expansion or the same old FOMO mega-cap growth favourites.

Sounds like the next few weeks leading up to the U.S. election will tell the tale.

There's no debating that.

Risk Model: 3/5 - Risk On

The bulk of the correction is possibly already over. Key moving averages have been tested. Flows out of equity funds were at modest levels, implying a 'hold-tight' mentality amongst investors. The headlines blared excitedly about the widely accepted negatives of the 'second wave' slow down and there was no panic selling. A choppy sideways correction is now the base case.

A bounce in risk premia due to the election uncertainty is keeping the 3mo VIX futures prices higher than spot levels. That has negative implications for the model, but fully reflect transitory 'election protection' positioning.

AAII Bull/Bear level, shown below, seems to be a coincident variable but continues to reinforce my view that this is a good time to be a contrarian bull. The data show the longest continuous period of bearish plurality (sub 1:1) in history. The glass is now half full. These bears can now only be buyers - not sellers.

Once the all-clear is blown on the COVID ravaged economy, they will get off their duffs and start getting more bullish. The FED has seen to that, depressing competing yields. Stocks are still 'cheaper' than bonds - especially the unloved financials that now have more upside than downside if no more black swans drop down from the investment skies. Post-pandemic valuations will most likely be higher for economy-sensitive stocks, so what are you waiting for? Oh, yeah, the upcoming earnings will be bad. I can't wait to buy that news!

AAII BULL/BEAR RATIO