Releasing the Tension

The move you saw off that CPI number which was just slightly cooler than expectations was a sigh of relief rally.  So much tension was built up over the 1st quarter regarding inflation that CPI became the most feared event on the calendar.  

Yesterday, you got the most feared economic data point released and that caused a buying stampede in stocks and bonds.  The biggest wall of worry has been inflation, and the CPI report has taken on renewed importance in the past few months.  Whenever investors focus on an event like this, you get distortions in price action and before and after effects which are more predictable than your random non event day.  As much as they say that algo trading and systematic strategies have taken over a big portion of trading, its still humans who pull the strings.  What you saw yesterday was a release of tension that comes from putting a feared event in the rear view mirror.  With that release of tension, investors became more eager to buy stocks and bonds even though yesterday's CPI won't really change Powell's reaction function.  But just not having something bad happen, which many feared, especially after the higher than expected PPI number on Tuesday, was enough to rocket this market higher.  That release of tension and reduced uncertainty usually leads to higher prices.  And that's exactly what happened yesterday. 

Sure, there are still your inflationistas who fear that inflation will remain sticky and that the Fed will not get that beautiful soft landing that so many are forecasting.  But even the inflationistas will admit that inflation is bad for bonds, not necessarily bad for stocks.  All you have to see is the performance of TLT vs. SPY over the past 18 months.  While yields have been going higher, so has the SPX.  

These days, you see very few who fear a hard landing/recession.  Even with the softer economic data lately (hard data, not soft data this time), most are looking at forward looking indicators (mainly financial conditions aka stock prices/credit spreads) which point to no signs of a recession anytime soon.  It is a consensus view, but its also likely the correct view for the next few weeks.  So you can't fight it, even at these lofty valuations.  

But let's not forget that even hard landings and recessions have a period of time before things get really bad where a slowdown is viewed as a soft landing.  You saw that in the fall of 2000, and in late 2007. 

With new all time highs comes opportunity, as the higher the SPX goes, the more potential energy builds for a sharp correction.  April proved to be the dip that refreshes, clearing out weak hands like CTAs and trend traders.  You also got enough of a purge in long positioning among asset managers in SPX futures to enable this market to go higher with fewer weak hands.  Asset managers have started to rebuild their net long positioning as of last Tuesday, May 7th.  It probably takes at least another 2 weeks for the latecomers to come on board, and then it will time to look for downside plays.  Over the rest of the month, we are likely in that low volatility grind higher/flattening out part of the rally.  The coming reduced volatility will likely lull investors into complacency again and then we can have another dip.  Right now, just on the sidelines waiting for the market to develop for a potential short play.