Sigh of Relief

Phew, that was close.

Fed officials are seldom as blunt as Christopher Waller was when yesterday he was quoted as saying that rates would have to rise in inflation came in hotter that expected in today's CPI report. Thankfully, it didn't.

But you cans see the level of angst in capital markets in the internal correction that was playing out recently. The US2Yr bond yield touched 18 month highs yesterday on the report of Fed hawkish commentary from Chris Waller and stocks gyrated mostly to the downside. Although it has been a mild correction mild when measured at the index level, the momentum of this market has run out of steam.

And what are we to make of the collective shrug from the risk markets to Trump's latest u-turn in the Iran debacle? Are we so inured to the policy reversals from the Child King that in doesn't matter anymore? Won't he just put another batch of TACOs in the oven and climb down from his untenable stance and once again capitulate? The market is sure acting like he will.

Summer doldrums will soon set in. Markets will go through the earnings season by selling the upside surprises while punishing the downside misses. After that, and with the Iran question still hanging out there, investors will head to the sidelines and volumes will shrink. PE multiples have corrected from nose-bleed levels as earnings have backfilled the first half rally quite nicely. But for a resumption of the bull a fresh catalyst is needed.

Prospects for a broadening out of economic performance are improving, but the signals have been mixed. Labour statistics have been confusing with a declining participation rate responsible for keeping a lid on unemployment levels. Credit delinquencies have stabilized despite the failure of real disposable income catching up to the recent energy and food inflation. Housing is mostly a neutral influence on economic behaviour as affordability gradually improves, but starts have dropped sharply. The 'K' shaped recovery is most evident in consumer behaviour when the boom of high-end aspirational travel spending (my buy Air Canada story) is contrasted with the moribund low-end housing and retail sales numbers.

Without a concerted decline in interest rates and more definitive signs of a recovery in the bottom income stratum, there is little prospect of further improvement in consumer sentiment. And the upcoming political season is unlikely to engender renewed US consumer confidence. The prospects for interference or even an outright manipulation of the Midterm election could be a catalyst for a non-economic market contraction as a constitutional crisis erupts. The focus of the bond bears will quickly shift from inflation to creditworthiness in that extreme scenario. The outcome would be the same - 10 yr yields above 5% and stocks in a cyclical bear market of minus 20%.

I have given up on expecting any quick fix to the dangerous and dysfunctional effects of Maganomics. Trump, unlike Julius Caesar, doesn't seem to have anyone behind him who is carrying a knife, so get used to more tariffs, fiscal stimulus and corporate welfare than you can handle. Again, the status of the US as reserve currency may come into question, thereby causing a sudden interest rate shock. The bond market is producing a bumper crop this year as debt-fuelled Hyperscaler cap-ex surges and US Treasury issuance soars. If this excess supply is met with any demand vacuum - look out below stock market!

This morning's rally on the inflation surprise may be a cooling breeze - certainly welcome given the recent heat wave. But don't let your guard down. An market that has become so narrow and concentrated and with little valuation wiggle room, should rates suddenly rise, you won't breathing a sigh of relief, you'll be gasping for breath.

Risk Model: 2/5 - Risk Off

The Model remains on the sidelines as the resiliency of the averages perpetuates the overbought condition, while AAII sentiment remains subdued. Only a strong Cu/Au and a subdued VXV are staying the course. I'd still be taking profits here, especially on the Banks. They are back-door Tech plays as the bulk of their recent earnings momentum has come from IPO, trading and financing of the tech buildout. Wealth management stocks, banks included, have become overbought and expensive, used as proxies for the bull run in AI spending and soaring stock market. Remember, pigs get slaughtered!

The broadening out I talk about is demonstrated below by the ratio of the equal weighted index against the Tech-heavy S&P 500 ETF, SPY. It is fading at downtrend resistance and needs more work to become a trend worth betting heavily. The bottom half of the 'K' needs to start rising for this to happen.

Equal Weight ETF vs Index ETF - S&P 500