The guest commentary below was written by Christopher Whalen. He is the Chief Investment Officer of Delphi Capital in San Diego.
We never fail to be astounded by the cognitive dissonance that reigns in equity markets toward the end of investment cycles.
Part of it can no doubt be attributed the incessant bullish proselytizing of the "Tri-pump-erate" - i.e. 1) Wall Street, 2) the financial media, and 3) incumbent politicians - all of whom benefit materially from higher stock prices and all of whom have a less-than-stellar track record of demonstrating scruples let alone ethics.
The rest can surely be blamed on run-of-the-mill avarice and FOMO, which are of course intrinsic pitfalls of human nature and hardly the purview of financial markets alone.
All markets eventually adopt the peccadilloes of their participants, and indeed the U.S. stock market has been exuding a "don't bother me with your silly tales of poor risk/reward...we're going higher" for nearly two years now. In the Trump Era, anything can be spun bullishly...and routinely is. But one of the linchpins of the year-to-date rally is that the Fed must and will accommodate the bulls - and there are a dozen different arguments why.
In our view, the market seems to have missed the change in Chairman Powell's tone last month: we picked up an unmistakable anger smoldering under the surface of his usual staid facade. It would, quite frankly, have been strange if it had been otherwise: Mr. Powell has been publicly humiliated by President Trump over and over since last summer and we're not sure that the Dalai Lama himself could have skirted a degree perturbation.
We are not in any way suggesting that Mr. Powell will adopt incremental hawkishness in retaliation - he is a a professional - but we absolutely believe that he has become more committed than ever to avoiding any appearance of political malleability. That, at the margin, is not a good thing for Mr. Trump or the stock market.
Talk being cheap, let us move now to the data, and the data unmistakably shows that the bond and Fed Funds futures markets have picked up on these vibrations: per the CME, the probability of a 50 bp rate cut at this week's meeting has fallen to zero after being as high as 40% this summer; the probability of a 25 bps cut has fallen to 65% from nearly 100% last month; the probability of no cut at all has risen to 35%!
And yet stocks hover less than 1% below all-time highs, still sporting extreme valuations and still under the spell of the "Trump put" (the potency of which grows more tenuous by the week as the President's credibility craters). We therefore can't help but facepalm ourselves at all this nigh-dogmatic chatter of a material growth acceleration in Q4. It is nothing if not extremely premature.
What the market should be fixated on is inflation, which is accelerating and which may have gotten a turbo boost from the drone strikes on Saudi Arabia's infrastructure over the weekend and the concomitant fears of protracted tensions in the Middle East.
Bottom line: when we look at Q4 from our perch in mid-September, we see a much higher chance of stagflation than Goldilocks reacceleration. The comps are indeed a lot easier, but a market that has for years now behaved as if inflation is a trite anachronism is in no way shape or form prepared for the Fed to be constrained.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Tim Boyd of Delphi Capital. This piece does not necessarily reflect the opinion of Hedgeye.