This special guest commentary was written by Peter Atwater of Financial Insyghts.
Source: Max Pixel
If you thought economists were struggling to reconcile the recent conflicting flurry of “hard” and “soft” data, just try being a financial markets reporter today. With the US Treasury market signaling recession dead ahead and the Nasdaq 100 at an all-time high, creating a coherent narrative that reconciles the opposing views of both markets at once is at best challenging. Take this valiant effort, for example, pulled from James Mackinstosh’s latest column in the Wall Street Journal, “Technology stocks’ return to favor [suggests] investors are looking for companies able to deliver growth even if the economy is weak.”
Got it? High beta is the new defensive.
At a moment in history in which “fake news” is a thing, I suppose simultaneously opposing market signals should be expected. That, however, does not diminish our current, precarious position. Someone is seriously offsides here. Either the stock market or the bond market is telling the truth. Both, however, can’t be right.
I have long been on record suggesting that the Trump Trade was the ultimate “relief rally.” The post-election rotation out of bonds into stocks was a case of emotion getting well ahead of underlying confidence. Investors bought hope in size.
But it wasn’t just that investors flooded the market that bothers me. It was that retail investors finally came in.
The novice and naïve showed up, as they inevitably do, at the very peak in price. While not in any way saying that the S&P 500 can’t and won’t follow the Nasdaq to a new nominal high - especially now with a Macron runoff victory over Le Pen seen as inevitable - everything I see suggests that “relief” is fading and fading fast below the surface.
Consumers’ outlook is now negative and back to where it was just days following the election.
At the same time, though, I would note that while bond yields have fallen sharply, I haven’t seen the kind of media headlines necessary to suggest an extreme in sentiment is now in place.
The most pointed bond market headline I could find this week was this one from Bloomberg:
I am sorry, but markets don’t turn on “it’s a short squeeze” level sentiment. At the turn, when it comes, the shorts will have capitulated. Nothing I have seen so far suggests that we are anywhere near that point yet. Given how extremely short bond investors were just a few months ago, there is still more to be worked off.
Finally, I can’t underestimate how much event risk is being discounted right now.
If investors were concerned about this weekend’s French election, you would never have known it from this chart.
Investors barely stopped to take a few puffs on a Gitane cigarette, before resuming their bullish run.
But what is most worrisome to me is just how little attention is being paid here in the US to the latest ISIS attacks in Europe. Back in early March, as oil prices were begin to drop sharply, I cautioned that if the experience from 2014-2016 held – in which falling oil prices correlated with a rise in terrorism – we would see an increase in ISIS-related violence.
Here is an update:
While two doesn’t make a trend, the mood backdrop for a possible – and major – attack should not be ignored, especially with the US Military having recently dropped the “Mother of All Bombs” against ISIS in Afghanistan.
Not only would an attack potentially upend investors’ current complacency, but it could also swing the French runoff. As we have seen for some time, falling confidence and nationalism go hand.
As I see it, bonds look like they have further to fall, while stocks look tenuous at these levels. The “Trump Trade” relief rally looks like it has run its course. With conflicting hard and soft economic data and being mirrored by financial markets poised for both success and failure, it feels like something is about to give.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor note written by Peter Atwater, founder and president of Financial Insyghts. He previously ran JPMorgan’s asset-backed securities business. He is also the author of the book Moods and Markets (FT Press, 2012) which details how investors can improve returns by using non-market indicators of confidence. This piece does not necessarily reflect the opinion of Hedgeye.
