A wise man can learn more from a foolish question than a fool can learn from a wise answer.
-- Bruce Lee
Readers of my Buzz & Banter writings
(subscription required) and Lead-Lag Reports know that I have been quite negative on equities since the end of January given the behavior of intermarket trends since then. Put simply, a deflation pulse has been beating beneath the surface, ignored by pundits who prefer to look at the Dow
(INDEXDJX:.DJI) rather than inside it. The entire thesis has been that the Fed's $85 billion per month would force reflation, accelerate economic growth, and finally get us beyond the muddle through. In the face of continuous money printing, then, stocks are the only place to go.
However, nothing is confirming this thesis whatsoever. Ask yourself: Should bond yields be falling if the stock market is right? Should the dollar be firm? Should dividend sectors be leading? Should cyclical sectors be lagging? Should the yield curve be flattening? Nouveaux Bulls are pointing at the Dow, but Gray-Haired Bears are pointing toward everything else. It is as if everything is saying $85 billion/month is not enough. Put simply, those areas which, factor wise, are most sensitive to inflation are failing to outperform. While this may seem counterintuitive, it is not opinion. It is how price is factually acting.
There are two primary sources of inflationary pressure: demand pull and cost push. Demand pull inflation occurs through a pickup in jobs growth, higher consumer spending, and confidence in the economic outlook. Recent economic data indicates none of this is happening. So on that front, demand pull inflationary pressures are not there.
Cost push inflationary pressure comes from the commodity side. The idea there is that higher input prices cause higher final goods prices which force supply prices higher. That isn't there either. Take a look below at the price ratio of DB Commodities Tacking Index ETF
(NYSEARCA:DBC) relative to the S&P 500
(NYSEARCA:SPY). As a reminder, a rising price ratio means the numerator/DBC is outperforming (up more/down less) the denominator/SPY. A falling ratio means the opposite.
Note that this is not just a gold (NYSEARCA:GLD) story. Commodities have gotten no love since QE-Infinity began. The relative collapse, one might argue, is bullish for stocks. This, however, assumes that the decline isn't due to deflation expectations rising. Our ATAC models used for managing our mutual fund and separate accounts continue to remain defensive, profiting from the deflation trade.
This is a highly fragile and deceptive environment. I championed the reflation theme last year when few else did and was highly bullish in 2012, the best year for stocks since 2009. The exact same methodology which led me to that conclusion is sending significant warning signs now. While the honey badger stock market may ultimately not correct, I prefer to wait for conditions to improve and actual reflation confirmation. What about you?
No positions in stocks mentioned.
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