Another mid-single digit correction has apparently come and gone—like yet another one of these nasty snow storms that we’ve been getting hit with on a weekly basis here on the east coast. Or has it?
The new year started with a decline that no one saw coming, one that was scary enough to make everyone question the validity of the preceding rally. And all of a sudden the S&P 500® was down 6% from its highs. And the next thing you knew, the market found a bottom, and then a mere seven trading days later the S&P had erased almost the entire decline. Seven days. It makes me wonder what all the hoopla was about. Maybe we should just assume that these corrections are just noise.
After last week's strong rebound, it seems that the market just wants to go up, either because the economy has achieved self-sustaining GDP growth or, if it doesn't, because the Fed will deliver more QE. It makes me wonder how much longer the Fed can exert so much control over the market cycle. Emerging markets, however, remain the biggest risk to this bullish scenario.
At the moment, we have stocks going up, the economy slowing, yields falling, the dollar falling, and gold rallying. Now, does that sound like a familiar combo? It should, because this is what the post-global financial crisis reflation trade has been like. The recent slowing economy theme certainly fits with this. A slowing economy could lead to more Fed easing (or at least a stop to the taper), which leads to a lower dollar, lower yields, higher stock prices, and higher gold prices.
What’s important to remember is that while most casual observers look to the stock market for guidance, what I think is really driving the bus here is the dollar and emerging-market currencies, both of which are now weakening. This is why gold and silver are rallying and why commodities are up at a time when most people would least expect it. We’ll have to see if this becomes a trend.
New highs for the stock market would not surprise me in what I call the “All news is good news” market—but I also wouldn’t count on it, given how far the market has already come. If you’re looking for a nonconsensus trade, it might be to add some commodities exposure in general and maybe gold, in particular. A weaker economy combined with a dovish Fed could trigger another reflation trade like what we experienced from 2009 through the spring of 2011. I think a commodity rally would be ironic given it appears that no one seems all that interested in commodities as an asset class anymore.
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