As noted in detail on May
14, it is always important to understand both the bullish and bearish
case for stocks. We recently noted two potentially bullish developments:
an unprecedented
drop in investor fear, and what appears to be a successful
retest of a long-term breakout for the broad NYSE Composite Index. While
the headline number for Thursday's GDP report was impressive, the report
contained something that may keep the Fed in a market-friendly mode.
A Dovish GDP Report?
A case can be made that this week's GDP report was skewed favorably by Uncle
Sam. From Bloomberg:
"The GDP number's fine, not spectacular," Michael Block, chief equity
strategist at Rhino Trading Partners LLC in New York, said by phone. "The
inflation data isn't great and the quality of the GDP beat isn't great
as a lot of it is from government and defense spending. It adds to dovishness."
Fear Of Deflation Impacts Fed
Low inflation can eventually slip into deflation territory. Once deflation
takes hold, it can morph into a negative feedback loop know as a deflationary
spiral. If you were surprised that bonds started strongly Thursday after
what appeared to be a strong GDP report, there is a logical explanation. Bond
buyers were focused on the inflation data. From The
Wall Street Journal:
The lack of inflation in the U.S. and around the world remains a concern
for economy watchers and a key factor keeping bond buyers around. Within
Thursday's GDP report, the price index for personal consumption expenditures
rose at a 1.2% annual rate in the third quarter, from 2.3% in the second
quarter.
Investment Implications - The Weight Of The Evidence
As noted in last week's video,
the improvement in the hard evidence has allowed us to scale into equity positions
numerous times in the past two weeks. The "fear reset" in the VIX is still
holding in a bullish manner for equities (see below). If the market can continue
to gain traction based on earnings, GDP, and tame inflation data, we will most
likely continue to increase equity exposure.
Concerns Remain
Europe's economy and low inflation could eventually impact the USA. We must
also continue to keep an open mind about all outcomes as the Fed begins to
normalize interest rates.
