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Vermilion Macro Vision: U.S. Equity Strategy

STRATEGY: Up, Up and Away

For those of us old enough to recall the common refrain uttered by the once mighty Underdog, “Up, up and away”, we can certainly draw parallels to the current U.S. equity market. It is often the case that we look at history to provides a timeline for which we can learn, reflect and to prognosticate the future. Whether analyzing politics, weather, or fashion, the past is always used as a comparison to the present and predictor of the future. On Wall Street, analysts, technicians, and economists glean over endless amounts of data to provide insight for what we should expect in the near future based on empirical evidence of the past. The market has had a tendency to head in an up and to the right fashion for some time now. We too have been bullish, and remain in that camp, but with some caveats of which we explain below.

• Internals remain healthy: The Russell 3000 continues to exhibit a healthy advance/decline line and remains near all-time highs. Put this in the plus column.

• Cyclicals remains leadership: Cyclical leadership indicates that economic demand is favorable and, since we're Minnesota Vikings, the offense is on the field. Deep cyclicals have come into favor over the past couple months, notably Energy and Materials have recently emerged from lengthy bases and have raced out ahead as leadership. We raised our weightings of both Sectors on January 3, to an overweight. Another positive.

• Defensive areas of the market are not leadership: Relative strength trends within the Consumer Staples, Utilities, and REIT's are extremely negative, and many are at multi-year lows.

• Small vs. large caps: Large caps are leading but there is no discernible breakdown in the small caps that would suggest anything more than a consolidation.

• Interest rates: The unwinding by the fed, and ratcheting up of interest rates continues, and we expect to see rates headed higher. This is one of our current concerns as it may send shockwaves through the equity markets. A breach of the all-important 2.6% level would indicate that the fed is likely to continue to tighten, and market expectations for a healthy to over-heating economy are much stronger than anticipated.

• U.S. Dollar: The greenback is taking a back seat to world currencies and we are concerned that the back seat may in fact be a rumble seat. Weakness in the greenback could also prompt a much larger unwinding in the bond market as capital losses only increase due to the currency decline. Certainly a potential negative for the
equity markets.

• Technicals remain constructive overseas: We pointed out in our November Strategy that many foreign markets went “too far, too fast”. While we have seen some pullbacks and a leadership move to the S&P 500 relative to the MSCI AC World index, it appears that globally, positive technicals remain intact.

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