Conclusion: Further Deflating the Inflation will make us bullish on growth-oriented equities from a price. We, of course, need to actually see that occur – which ultimately means the Fed must remain on hold long enough for market prices to “clear”. If the Fed is unable to resist the urge to ease, we’ll happily play the long side of the Inflation Trade up to another long-term lower-high in US equities – just as we did from JAN 25th though mid-MAR.
Hedgeye Macro Active Themes: Growth Slowing, Deflating the Inflation, The Last War: Fed Fighting, Bernanke’s Bubbles, Asymmetric Risks and Sovereign Debt Dichotomy.
Hedgeye Asset Allocation: ZERO percent exposure to commodities (since APR 5th) and international currencies (since APR 23rd).
This we know – on every down tick in crude oil prices, a legion of pundits will tell you to buy [US] stocks because of “declining energy prices”. This we also know – many of these are the same perma bulls who told you buy stocks with crude oil prices +10% higher because: A) “US growth was decoupling from the rest of the earth”; B) “QE_ would propel the rally higher”; or C) “high energy prices were merely a function of accelerating demand” (in spite of global growth data sequentially decelerating since FEB – but who’s counting?).
Given such obvious discrepancies, we find it useful to incorporate a consistent and repeatable research process to help navigate the thick haze of Old Wall Storytelling around expectations for growth, inflation and/or policy. Regarding the latter, our quantitative analysis of key market prices suggests that, while some noteworthy participants are already out begging for more QE, the Global Macro universe generally does not view incremental easing out of the Federal Reserve as a near-term event (USD breaking out; Oil and Gold breaking down).
Looking to the Fed’s own index of “medium term inflation expectations”, there’s still quite a bit of Deflating the Inflation that must occur in the TIPS market relative to current levels to justify pursuing further easing. The 5yr breakeven inflation rate according to the Fed is 2.76%; this is substantially higher than the 2-2.2% range when the Fed announced QE1, QE2 and Operation Twist. Interestingly, the strike price on the “Bernanke Put” has increased from 750 on the S&P 500 in ’08, to 1050 on the S&P 500 in ’10 and 1150 on the S&P 500 in ’11. Is 1250 the next logical step in this progression? Call us chaos theorists, but that roughly jives with Keith’s 1281 TAIL line of S&P 500 support.
As we penned in our MAY 4th research note titled, “Analyzing the Jobs Report Through the Lens of the General Election: April 2012 Edition”, we continue to view the general election debate as supportive of intermediate-term USD strength from a rhetorical perspective as both Bernanke and Obama are forced into an increasingly smaller box for the time being. If events ultimately play out according to our expectations, you’ll hear us get very loud about being bullish on the US/global economy and US/global equities – from a price. In our view, Bernanke packing up his moral hazard and getting completely out of the way will allow both the US economy and US equities to rally to new highs vs. the latter simply bouncing to another long-term lower-high on waning volume.
The phrase: “from a price” is paramount. As alluded to previously, you actually need to see a clearing of commodity market prices for Deflating the Inflation to occur and have a positive impact on growth. That roughly equates to more pain across the commodity complex over the intermediate-term in the name of reflating economic growth – an occurrence we saw in both 1H09 and 2H11. Without that pain, the disinflationary tailwind of falling commodity prices will peak here in MAY and decline through year-end (holding prices flat at current levels). For disinflation to continue being incrementally supportive, we need to actually see it show up via continued declines in commodity prices – not just consensus storytelling on the first leg down in crude oil!
All told, further Deflating the Inflation will make us bullish on growth-oriented equities from a price. We, of course, need to actually see that occur – which ultimately means the Fed must remain on hold long enough for market prices to “clear”. If the Fed is unable to resist the urge to ease, we’ll happily play the long side of the Inflation Trade up to another long-term lower-high in US equities – just as we did from JAN 25th though mid-MAR.