Bad News, Bears

Those of us looking for a major correction may soon be disappointed.

What was shaping up as a garden-variety seasonal period of weakness has suddenly become unpredictable. Despite rolling over, stocks remain within 2% of all-time highs after a bounce mid-week. I can be accused of waffling now. I accept that. Nobody has a monopoly on the future. But I gotta call 'em like I see 'em.

Stocks have come off the boil somewhat, as evidenced by the % above their 50-day average. Sideways corrections are still corrections, and the 40% is a spot where previous pauses have held in the past.

Stocks> 50 DMA

And what I see in positioning has me worried as a bear. The widely used CFTC Commitment of Traders report shows how expectations have played out lately. Large Speculators are short the bond market to the largest degree since 2023. Higher yield expectations are now the consensus in the speculative manager universe. Bonds are primed for a counter-trend rally.

Last week saw an unexpectedly strong August U.S. employment report, yet the 30-year Treasury yield failed to make new highs. Could it be that any data supportive of a FED rate hike is bullish for long bonds?

So what if the Fed gets a strong inflation print this week? The vote to hike, obviously. And the speculative positioning covers their bets, thus producing a curve-flattening bond market rally. The release of pressure on stocks will mean an instant rally in that market. Remember, that FOMO sentiment still runs the show until the Fed engineers an inverted curve.

But should inflation print weaker, Warsh & Co. will have the necessary cover to punt the rate hike down the road, avoiding a dust-up with Trump and Bessent. Stocks may grumble a bit more as long rates initially nudge higher, but continued easy financial conditions and lower inflation premia would ultimately support the markets.

Rather than viewing the back-up in bond yields as an existential threat, the optimists among us would treat it as a necessary, and long-overdue, realignment in the post-GFC era. Financial repression, as first practiced by Japan and followed by Europe and the US after the GFC, is being unwound - a good thing. What if the bond market is just getting back to normal? That would mean stocks can go back to the business of responding to the impetus of a strong economic push from the AI boom. All would be forgiven. With a 6% nominal GDP growth rate currently being experienced in the U.S., 5% yields are normal, if not slightly stimulative.

I have been bearish on bonds for most of this year, but am now dangerously subject to confirmation and anchoring bias. The twin negatives for the bond market, inflation and soaring deficits, are front-page news now and may have priced in the worst. It will be hard to be an equity bear when forward earnings are still rising, and competitive LT FI yields are stabilizing. So the key to being a good trader is not to get anchored by your past views.

Although I'd like a steeper stock correction to redeploy my cash, I'm just not sure I'm gonna get my chance now. From here to next week's Fed meeting will likely be choppy. The Iran news flow has a short-term negative bias, but could turn on a dime - or in the case of Trump a phone call from the Saudis. Impossible to predict. But these higher energy costs are a depressant on the economy, so chalk up another win for bonds in any case.

Unfortunately for bond bears, the bond market may have seen its worst. But that bad news may actually be good for risk assets.

Risk Model: 5/5 - Risk On

Rather than following through on the downside, the Model has abruptly righted the ship. The AAII Sentiment is starting to dig in its heels here. The much-needed buying power of these investors will be key in determining the next leg of this bull market. Meanwhile, the low volatility levels are keeping aggressive downside action to a minimum.

AAII Bull/Bear

CBOE 3-Mo Vol

Copper bulls have regained the upper hand as the tariff threat rears its ugly head and China inventories have dropped to new lows. The AI demand surge is real now that the data center build-out has gained momentum. Such an impressive reversal against gold is hard to bet against. Call me surprised but that's the markets for you.

Copper/Gold