Is it real?

The TSX composite index finished higher for a third consecutive day. Might have been four had Monday not been a holiday. But… is it real?

Mindful that a three-day rally does not make a bull market it appears there has been a major change in sentiment. Rallying in the face of higher oil prices is a shift in sentiment. As is the timing which has baffled more than a few analysts who have been touting the “invest ‘til May, then go away” mantra.
Sentiment around higher interest rates has changed from a glass half empty to one half full. It seems that higher rates imply a stronger economy which bodes well for stocks. Bonds… not so much!

Mind you, given the on again off again debate as to what constitutes the path of least resistance for central banks, there is no conviction that interest rates are going anywhere. Analysts have raised the probability that the US Federal Reserve will raise rates at their June FOMC meeting in June. But it is hardly conclusive. In fact, you could argue that with the Bank of Canada holding rates steady, the Fed will not move until the fall. Whatever the end game for rates we are seeing leadership in all the right places; read financials and technology!

The bear case leans towards the macro economic fundamentals. Economic growth is anemic! Wages have improved, but not to a level one would expect at this stage of recovery. Earnings have been flat to lower for three consecutive quarters which has caused a marked increase in the price to earnings ratio. All troublesome metrics… yet the band plays on!

As investors we have to play the cards that are dealt. In this poker hand we have a sentiment driven rally in a period of seasonal weakness with questionable fundamentals. Investors are complacent as evidenced by the low volatility and by extension option price are relatively inexpensive.

If you are concerned that stocks may be getting ahead of themselves, then consider buying puts on the iShares S&P / TSX 60 index fund. Buy say the XIU January 20 puts at 85 cents. That’s relatively cheap insurance for concerned investors.

If you buy into the “trend-is-your-friend” thesis you will be looking to ride the market to higher ground. Fair enough but with option premiums at the low end of the spectrum you might think about buying calls as part of a stock replacement strategy. In other words, sell your winners and replace them with a longer dated at-the-money call option. This is particularly useful for trading the financials which would be the major beneficiary of higher rates.