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
(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
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
(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?