A combination of mixed economic data and a bit of shyness from the Fed about QE3 has caused a rather unpleasant previous week for the bulls. At the same time, technical indicators say that we were more than due for a pullback given the steady and prolonged period of buying that has caused the ~11% appreciation in the S&P 500 this year.
Some bears are now arguing that China is going to slow down further, Europe is still in crisis, and that the US recovery is fragile. While these are all relatively true, I think it is more than offset by other factors. In addition, I find the alternatives to the stock market much less appealing at this point.
The employment recovery is still apparent, and it seems like it is because of this that the Fed is hesitant to even entertain the thought of QE3. Under their dual mandate, inflation is ideally kept at 2% while unemployment is minimized. If something happens to the jobs recovery, they will have a ton of room to adjust monetary policy in retaliation. They see price levels (and hence inflation) as stable, and well within their limits.
In a sense, the stock market can't lose. Either our jobs recovery continues and we see wage-inflation and increases of activity in the world's largest economy, or the Fed will eventually loosen its stance on expansionary monetary policy and we get a QE3 rally. In either environment, certain businesses can meet earnings expectations as they have been.
Supplementing the view that jobs are returning were Canada's employment numbers released on Thursday (7.2% unemployment relative to an expected 7.4%). A sluggish, but apparent recovery just like us. The ISM manufacturing index released on Monday also improved (53.4 versus 52.4 last month). Since this is often considered a leading indicator, we can be hopeful that this represents an acceleration of the extremely slow speed of the recovery.
Jeffery Lacker (the only dissenter out of 10 voters on the continued 0-.25% Federal funds rate decision going into 2014) seems to believe in this recovery, since he is more worried about the impacts of wage inflation. You can't have that without a recovery.
We've seen gold (GLD) and silver (SLV) take a very rough beating since the bulls seemed to place their anti-greenback bets a little too hard in recent weeks. The fundamentals have not really changed though, and there is still plenty of room for a continuation of the multi-year bull run in the precious metals. I think going short after the mini-crash we had last week is a very dangerous game.
In addition, I would like to note that the US trade deficit is still terribly wide. Between low interest rates, an improvement in the economy (especially in the labor market), an unfavorable trade deficit, and the potential reconsideration of quantitative easing upon an economic downturn, it's hard to find fundamental reasons that the dollar would appreciate significantly at this point barring any black swan events.
The US jobs data released last Friday wasn't so good though. The US added 120K jobs in March, while unemployment was released at 8.2%. This isn't anything to be proud of, but there are 2 things that keep stocks attractive even in an (incredibly) slow job recovery.
1.) Company earnings have been increasing (along with margins) despite the behavior of the labor market, causing cheap fundamentals on many stocks relative to historical averages
2.) Alternative investments (particularly bonds) are probably not safe when the Fed is scared to death of high unemployment numbers with a QE3 still possible.
So despite our strong performance this year, I ultimately find it difficult to short stocks and put faith in the bond market or anything else. The best way to play for most people is to go long and broad. (DIA), (QQQ), (SPY)