Dirty Work

"I'm a fool to do your dirty work" - Donald Fagen

Maybe, but the pay sure is good.

Extractive industries (Oil & Gas and Metals mostly) have been in the penalty box since the advent of climate change-driven investment policies were popularized. Their carbon-rich production processes were easy targets for climate advocates, and with good reason. This has spawned an ESG backlash from shareholders designed to reduce capital deployed in the offending companies. The ensuing starvation of capital investment has permanently reduced the potential supply of commodities globally.

That will be a chicken that comes home to roost at some point. Meanwhile, companies are spewing cash flow surpluses from their existing operations and are scrambling to find ways to spend. In the U.S. shale sector, there has been a spate of acquisitions. There has been a noticeable reduction in exploration expenses and workforce costs. Simultaneously, there is a 'return of shareholder value' from company CEOs that is reducing the share counts through aggressive buy-backs. Gone is the 'drill with debt' approach that fuelled the commodity super-cycle of the early noughties.

And the prices of the stocks have taken notice. I always go back to the charts for a longer-term perspective. And there have been some spectacular break-outs lately like Canadian Natural Resources (below). However, investors are constantly being inundated with AI and Bitcoin news and may not even be aware of these stocks' strength. The stealth expansion of the breadth of this market is a developing story. We are seeing a 'trickle down' from the past superstars like Tesla and Apple into the left-for-dead cyclicals and financials - a healthy sign.

The mixed nature of this month's Employment report and CPI hasn't changed the Goldilocks scenario for the U.S. equity market. Surprisingly strong earnings growth has continued to offset higher-for-longer interest rates and sticky inflation. BofA has again raised its target for S&P earnings to $250 as the backfilling of last year's PE expansion continues. The data has given the bulls and bears much to chew on but with neither view dominating the narrative. This is still not a tape to fight.

The 2 day sharp and short pull-back in the AI trade I warned about last week is apparently over almost before it began. Chalk up another victory for the 'hope is not a strategy' advocates. But that's why a bull market is so hard to beat - just saying a market needs to correct isn't nearly enough, you need the evidence that rates are going higher or earnings are going lower. With the mixed macro data this week, neither case can be made yet.

The bond market is stuck in a trading range. The Fed continues to dangle the carrot of rate cuts, keeping the few remaining bearish debt vigilantes at bay. The process of 'terming out' various asset pools such as pension funds and individual portfolios has bouyed the fixed income market, surprising the bears. The massive surge in U.S. government deficit spending that threatens to choke the bond market with supply has been matched by this duration grab. I see this as a temporary truce that will last only as long as the seasonal forces of demand remain strong. The back half of this year will be the true test as it typically is.

Meanwhile, stocks seem the best choice as they continue doing the dirty work.

Risk Model: 3/5 - Risk On

The rise in $VXV is reversing today, after a brief dalliance with the signal line. The negative signals from the elevated RSI and plunge in the Copper/Gold ratio don't seem to have gained any traction in the marketplace as the recent corrective action has not followed through this morning. The window dressing should hold this market up for a few more days with quarter-end looming.

An overbought market that internally rotates from story to story is the hallmark of early-stage bulls. Stock selection is the key differentiator for relative performance. Sorry. that's not my lane - I'm a macro guy.