Data still not suggesting it, but inflation may be picking up

Market Review

Yesterday’s market movement exceeded our expectations, with the S&P initially selling off from the high levels of Wednesday to the low of the very same day; before a notable retracement back to the highs. Nobody can accuse the index of being boring at the moment. On an intra-day basis it is extremely volatile, even if the overall direction is still uncertain. With Personal Spending and Income being posted just below market consensus and in both cases higher than previous, the move down by 15 points does not seem warranted, and we were not surprised to see the correction that came was a result of this. When sellers enters the market they know they need to exit quickly. Currently there is no way to make money for bears with a stubborn view until we finally see three down daily candles in a row (not seen since Jan). The EURSUD sold off in line with our expectations, but retraced at the cash close to see some positive correlation with equities, oil broke our entry as the commodity fell to test 105.00.

Today's Fundamental View

With yields trading at record lows, one may ask what is next for equities? As the US stimulus program ending is being replaced by a European stimulus program combined with better data, it is starting to dawn on us what will be the next natural move in the market; inflation. Even though data have not yet suggested it yet, we are starting to see some evidence that inflation is picking up. Many view this as a threat to the current recovery, though looking closer it may actually support equity prices not withstanding aggressive central bank action. Either way investors will not be likely to accept a yield on shares lower than what you would see in safe haven bonds, and a lower current dividend yield in equities is only warranted if the potential price increase is higher in the stock itself. Currently we see the first as the most appealing scenario, and we have yet to see inflation rates at those levels since the early 80’s. While many will yell “that’s above the target for the Federal Reserve!” we may add that we do not think the target for the Fed’s was a financial crisis in 2008 either. Things happen, and as long as over a period of say 30 years if the average inflation is close to the target the market should remain calm. Should we be correct in our prediction we will also see institutional investor move away from the propped up bond market which will finally lead to a much awaited correction which will be exaggerated by interest rate increases. In other words, if we trade at 2500 in 12-24 months in the S&P we would not be surprised, and all of the sudden 2000 does not seem so high. Record stimulus should equal record prices, and inflation is coming. Should we panic? No. Institutions like the Federal Reserve are set up to deal with situations like this, and one may look at it as the second wave from the Tsunami that was the GFC; the sea is a rocky place. Today’s strategy will follow the outline for the week; conservative entry on the S&P, long the dollar and crude as well as a short in treasuries. 

Alternative View

Hawkish monetary comment speakers from the Eurozone may adversely affect our strategies.