Stagflationary Signals Abound But It Might As Well Be Spring For Giddy Equity Investors — What Fixed Income, Currency & Commodity Markets Are Telling Us
Despite persistent inflation data and fears of a credit crunch the consensus outlook for profits remains positive and that’s driving equity markets higher this morning. The volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought one positive factor for US stocks. The US yield curve is rising and in the current context that is bullish. Expect the S&P 500 to rise modestly over the next few days.
Equities continue to outpace other major asset classes in enthusiasm for the global economy, as fixed income, currency and commodity markets signal modest stagflation but equity investors look through to bright earnings growth in 2024 and beyond. While profits are a natural hedge against inflation the valuation of equities depends on the expectations for both profits and interest rates over the long-term. Bullish investors are keying off of placid inflation expectations as given by treasury securities and consumer surveys, while ignoring the decline in earnings quality last year and the political-cultural changes that will continue attenuating productivity this decade.
And the interest rate picture is likely to turn negative given volatility expectations expressed in the Move index, which not only reached record highs this month but has remained persistently high despite a huge treasury rally. Credit spreads are tightening once again and key will be whether they stall at current levels or manage to tighten further to the lows of midwinter. Given the action in currencies I expect spreads to widen again and the yield curve to move up as low global growth persists and keeps inflationary psychology intact. The major currencies are consolidating earlier gains but key EM/dollar pairs like the Mexican Peso, Indonesia Rupiah and Philippine peso are testing earlier highs. Profound disinflation is what the equity market really needs to justify current valuations and neither the data nor the action in commodities is forecasting that. Fossil fuels are consolidating, but many ags, meats and softs have reversed and are now uptrending while precious and industrial metals are consolidating but with more upside risk than downside. As long as markets are presaging both low growth and inflation a retest of the October lows is just a matter of time.
My current positions include a smaller but still large cash position, 3M (MMM), Pfizer (PFE), and the levered ETF UPRO and inverse levered ETF SPXU.