Is the big BEAR finally hibernating?
There you have it, it's official. According to the Prognosticator of Prognosticators Punxsutawney Phil, our furry groundhog friend, there are 6 more weeks of winter.
Ugh... Really Phil?
I know Groundhog Day is full of lore, and Phil's accuracy is a mere 40%, but winter has been brutal this year and I am ready for a change!
I am sure I am not the only one.
And given the recent stock market rally, investors are looking for thawing in the capital markets, as well.
But is there any truth to this rally or should the bulls temper their enthusiasm?
In short, I am cautiously optimistic. Which is a far cry from where I was just two months ago.
If you have been following along, I have pointed out several bullish divergences taking shape over the past few months. (read here)
But, I need to drive home a strong point here.
I use "cautiously" in reference similar to the yellow flag that's waved in a formula 1 race. 'Reduce speed, do not overtake, and be prepared to change direction,' there is debris on the track.
The current rally has been fueled by the assumption that the Fed will lower interest rates (an actual pivot) starting in late Q3 or early Q4 of this year.
The assumption also bakes in a higher probability that the Fed will be able to land this economic plane softly reaching their 2% inflation target. And through it all corporate earnings will come in stronger than feared.
Don't get me wrong. I love a good rally, but not all data agrees.
Disconnected Data
Leading and lagging indicators offer a differing outlook and the bond market agrees to heed caution.
The chart below shows the leading economic indicator index (LEI) flashing warning signs that a recession may still be on the horizon.
Similarly, the bond market is not certain about the bull scenario either as the current 2 to 10-year spread is at its deepest level since the 1980's.
With a healthy or normal yield curve, shorter-term treasuries typically pay less than longer-term dated treasuries. In this environment, liquidity is fairly abundant.
When the yield curve is inverted the opposite is true. This is due to restrictive monetary policy and it does a number on liquidity.
*Quick note: Liquidity is necessary for all markets to function well, but it is extremely necessary for speculative investors.
Given that a yield curve inversion has successfully called the last 9 recessions since 1955, with one false positive, it must be paid attention to (of course, some of that data must be back-tested).
But let's be fair to the data.
While the yield curve and leading economic indicators have been signaling a recession, other data such as the lagging indicators that the National Bureau of Economic Research (NBER) tracks to actually call a recession has held up, as of right now, AMAZINGLY well.
The Fed also noted disinflation starting to show up in the personal consumption expenditures (PCE) of goods, which is encouraging.
But the same cannot be said for services and housing as they have not budged. This will have an effect on the fed's "data-driven" decision-making for the Fed's loose or monetary policy moving forward.
Furthermore, the yield curve inverting to this extent has given some investors confidence that the Fed may reign in its hawkish stance sooner than they let on.
Note: It is hard to cover every topic in these outlooks… If you are curious to know more about my thoughts on other bullish divergences topics feel free to connect with me here.
Conclusion
No matter how mixed the data is, there is one thing we know to be true: The market has survived wars, depressions, and pandemics and it will exist long into the future, no matter what the Fed does.
The current rally has been fairly violent in most sectors. From a technical picture, many strong moves are happening underneath the surface, which has me optimistic.
If you are a client you will notice that our cash positions have gotten smaller as I have been adding positions to portfolios.
But there are dark clouds surrounding this rally and based on my indicators the market is overbought at the moment. I suspect a pullback in the near term which will help us determine if this is a sustainable rally or simply a relief rally.
Regardless, the future is bright. Take care of your health, families, and loved ones because they are the most important!
“If you're going through hell, keep going” ― Winston Churchill
Thank you for reading,
James Anadon
