"If people aren't in sync, things won't work out well." - Stephen Hopkins
The S&P 500 (SPY) hit new all-time highs last week, rallying strongly following the prior week's disappointing jobs data despite retail sales data coming in poor, softer PPI, weak consumer confidence, and another pulse lower in commodities which seems to be indicative of a liquidity scare. Bonds (TENZ), following one of the best weeks since 2011, sold off a bit, with the 30 year yield still below the panic 3% level. The rhetoric by bulls is that stocks are anticipating some kind of breakthrough economic growth ahead given how high the Dow (DIA) is. The problem with this of course is that a market led by inelastic, non-cyclical sectors is not discounting better growth. One must look within the markets, not at them, to see what is truly being anticipated.
Everything I do is about identifying the conditions under which asset classes tend to outperform. Historically, when inflation expectations rise based on intermarket price movement, stocks tend to do better than bonds and rise. When the opposite occurs and a deflation pulse beats, bonds tend to generate gains, volatility tends to rise, and stocks tend to fall. While Nouveaux Bulls continue to point at the Dow Jones Industrial Average, the Gray Haired Bears are pointing towards everything else. Cyclical emerging markets (EEM) are severely underperforming year to date. Defensive sectors (XLP) are leading. Growth sectors are lagging. Commodities (DBC) are breaking. Europe (VGK) is wobbly. And bond yields are falling - completely inconsistent with the reflation story which stocks believe in.
While many talk about the trend in U.S. stock prices, no one is talking about the trend in conditions which are clearly signaling deflation despite the Fed's $85 billion/month. With commodities down (cost-push), and the jobs market still not signaling any real acceleration (demand-pull), the two most basic forces of inflation aren't doing much at all. This is what Ed Dempsey and I have been stressing since the end of January with many ignoring what internal price is clearly saying.
This is one of the most risk-off risk rallies in history, which is highly deceptive given what is causing it. I went from calling this a market which could be set up for a correction in late January to the honey badger stock market which simply does not care about negativity in nearly every other area of the investable landscape. However, make no mistake about it - something's gotta give. There will be a Spring Sync. Either absolute price movement will converge on the downside to intermarket deterioration, or that deterioration through time will resolve itself and the next fat pitch comes in the cyclical trade. If the former, it is entirely possible a sharp sell-off occurs despite Fed intervention. If the latter, cyclicals have the potential to make any year to date gains in stocks look more like a rounding error.
Facts are fact - the deflation trade is working, and the disconnects are now too wide to ignore. Our ATAC models used for managing our mutual fund and separate accounts continue to act defensively. The world is in uncharted waters given the aggressive monetary policies of the Fed and now the BoJ. Whether actual reflation will show up in the economy is still unclear, but a stock market that moves up on expectations which fail to materialize tends to have material drops.
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