Beachhead

I'm baaack!

Tuesday at 11 is alive and well despite reports to the contrary. I had an eventful summer that included a 300-nautical-mile sailing excursion, an epic 150-km bike ride, and many relaxing days spent lying on the beach. Time to shake off my beachhead, I'm now ready to opine and whine!

What did I miss? Same old, same old. The U.S. stock market, led by Nvidia and Google, continued to rise on an AI-driven rally. The arms race to capture AGI first mover advantage has dominated capital spending and driven the arms dealers ever higher. I question the bubbly nature of these expenditures, as, with most investment booms, the use case often lags behind the buildup in capacity.

A late catch-up rotation to Small Cap and Financials has extended the already stretched indices over the past 3 weeks, on hopes of a Fed rate cut. Chair Powell hinted at this in his remarks at the recent Jackson Hole gabfest. The 'Independence Day' lows have turned into the Labour Day highs based on easy financial conditions and improved market sentiment. No sign of the Taco tantrum yet.

Risks are still lurking in the background, but markets always climb a wall of worry. Will the bond vigilantes have their day? Will the tariff effects on inflation, delayed but not deferred, hit inflation expectations? Will the Big, Beautiful Budget Blow-up wreak havoc on fixed income confidence?

And is the risk of a Trump-Fed dust-up the last straw for foreigners' belief in U.S. exceptionalism?

Too soon to tell. But if the market is going to take a breather, now would be a good time.

Despite being offside since June, my call for a significant correction still stands. The market has run out of steam, and the Powell rate cut - if it even comes - should be a sell-on-news event. Lowering rates due to a sharp increase in unemployment is hardly the type of news that induces risk-taking. The plunge in the Copper/Gold ratio has signalled this slowdown for weeks now. After a tariff-induced short squeeze in July was wiped out, the red metal is signalling weak demand for industrial use.

Copper:Gold

The Johnny-come-lately rotation to Small Cap smacks of hope over reason. The move is predicated on the possibility of an easier Fed, combined with the news of a successful challenge to Trump's tariffs. However, the typical mechanism of a stock rally that follows Fed easing assumes that bear market conditions have prevailed, allowing for a valuation recovery scenario. At 23 times expected earnings on the S&P 500, I see no such precondition.

And if you think tariffs will magically disappear after the Kangaroo Supreme Court hears the case, you haven't been watching them lately. If they can uphold Trump's birthright citizenship views, they aren't likely to stop his executive orders under his Reign of Terror. No matter, Scott Bessant is already scouring the lawbooks for other loopholes anyway.

All this before we get to the real showstopper for risk markets. The Midterms. Trump's January 6 was just a practice run for his next objective: a full-on neutering of Congress. His Texas gerrymandering is like a warm-up pitch. The real fight begins once he is threatened with a split Congress under a likely Democratic House. I'm not looking forward to this fight starting in earnest.

So let me summarize. We have a decelerating economy facing a substantial structural shift in its cost structure, combined with an overbought stock market that offers no valuation upside and a potential for bond yields of 5% or more. AND we're heading into the worst seasonal period for risk assets. Oh, yeah, let's throw in a constitutional crisis for good measure. Sell!

Welcome back, beachheads!

Risk Model: 2/5 - Risk Off

The Canadian market is now 10% above its 200 DMA and above RSI 70. VERY overbought! A surprisingly strong bank earnings season caught the shorts napping, and the squeeze is on. U.S. Hedge funds love to short Canadian banks despite their oligopoly status and fortress capital. They probably don't get the poutine thing either.

Momentum has taken over as the dominant factor in markets - a typical late-stage behaviour. Quality Growth has started to fade, and Value, despite the recent bounce, remains in the downtrend established in 2022 (chart). The rotation that I expect should be established in a corrective phase that captures stranded bulls in the leadership of the prior cycle.

Value/Growth Relative Performance

Sentiment has bounced off the April low but is now fading. Fund flows into gold-related ETFs have surged as confidence in the US dollar wanes. I made a few mistakes in my career, but selling early was never one of them.

AAII Bull/Bear Ratio