Friday, July 14, 2017

Bad Data is Good for Stocks

We are back to the bad economic data is good for stocks price action.  Retail sales came in less than expectations, as well as inflation, and with yields going lower, stocks are pressing back up towards 2450 again.  It didn't take long for the market to forget last week's worries about higher interest rates.  We are getting to interesting levels on the short side this morning, but I don't want to pull the trigger because of the strength in bonds.  I would much rather just short the market when only stocks are going up.

I anticipate bonds being strong all summer, so it's not going to be easy pickings to short stocks unless data gets really bad.  And right now, data is just mediocre, enough to keep yields from going up, but not so bad that it affects earnings.  The only way I see yields going up for more than a few days is if tax cuts go through.  Oddly, the tax cuts that equity investors so badly want would probably be the nail in the coffin for this bull market.   While tax cuts would be a short term positive for stocks, it would be a long term negative because it leads to higher yields from greater bond issuance.  The small economic gain from tax cuts would be taken away by the negative effect of higher yields.

In 2015, you had an attack on risk parity (bond yields were reluctant to go down as stocks went sideways) which was the precursor to the 2016 down move.  Right now, you don't have that.  You did for a few days at the end of last month, but Yellen went right back to looking away from asset bubbles.

She gave her seal of approval to this bull trend in stocks, which is not surprising because the Fed talks a tough game but usually doesn't follow through.  At least Yellen was honest that the Fed boilerplate message of transient inflation and strong labor markets was just a pretext to put through a  few rate hikes.  Now that the Fed fund rate is back above 1%, she doesn't feel the urgency to keep hiking.  Unless the stock market keeps making new all time highs and busts out over 2500, what Yellen said on Wednesday should be the new boilerplate message.

This year, unlike 2015, bonds are looking bullish and that should make it harder for stocks to go down without some kind of shock to the system, which is lower probability.  I am still leaning bearish, due to valuations, but current financial conditions are still loose enough that stocks could grind a bit higher than expected before getting hit with a correction.

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