Equities May Have Soared Too Far Too Fast But The Fed Is More Concerned With Disinflation That’s Too Slow And Too Frangible — What Fixed Income, Currency & Commodity Markets Are Telling Us
The bulls defend the recent ennui among equity investors as nothing more than a welll-deserved breather from a volatile 6 months between the October swoon and the March banking crisis. But the drop in volatility and volume reflects uncertainty rather than complacency, as investors wait to see whether earnings quality ratifies bullish optimism or extends the downward trend begun in 2022. The evidence from global economic indicators point to continued decline in quality and this all but guarantees that valuations will swoon once again. But for now the volatility risk premium is pointing to a range-bound 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. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. But there was also one negative factor across global asset classes. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to rise modestly over the next few days as it tries assailing resistance at 4200.
Unrealistic expectations for fast disinflation is one reason the bulls are misguided in defending current valuations. Commodity markets continue to stutter-step toward lower prices, keeping the Fed vigilant lest geopolitical or weather changes reverse the course of disinfation. Precious metals have broken out while industrials are mixed, suggesting $ weakness and persistent inflation rather than fast disinflation. The divergence also suggests low levels of global growth, which undermine the case for robust earnings growth in 2024.
Oil has led other fossil fuels and distillates higher but all look set to consolidate now, with equal downside risk. Most foods and softs are consolidating, with meaningful downside risk. Thus headline inflation risk remains a modest issue but the Fed can be confident that over time inflation will come down to its target of 2%. With volatility in fixed income off its highs and the $US at relatively benign levels against both the majors and EM, the Fed has little reason to change its course for fear of triggering another banking or shadow banking crisis. Higher for longer interest rates and low global growth portend a drop in equity valuations, which I see playing out as earnings reports fail to confirm bullish exuberance.
My current positions include a very large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a modestly long position in large-cap equities.