Media (including this newsletter!) is full of inflation and recession warnings, three U.S. banks have collapsed in past two months, ominous macro-economic data are screaming serious risks, and yet the global stock prices are marching ahead. U.S. GDP growth came at a weak 1.1% for March quarter against expected 2% but markets kept on rising, why – because 1.1% is still a growth, no recession yet! Markets are in a risk-on mode. It looks like a good bull case.
Market can behave differently then what it is expected to do. There are at-least five reasons as to why this up-trend may continue –
1. Inflation on decline
Inflation (CPI) rate – U.S.
Inflation (CPI) rate – Euro Area
Inflation (CPI) rate – China
Inflation (CPI) rate – India
2. Good corporate results
About half of S&P 500 companies have reported Q1 earnings thus far. Of those companies, 80% have beaten expectations, according to data from FactSet.
Corporate Q1 earnings of global majors like MasterCard, Harley Davidson, Domino’s, Caterpillar, BYD, Hasbro, Chevron, Exxon Mobil, Facebook, Barclay’s, Deutsche Bank, American Airlines etc. all have beaten estimates and have shown that demand is on rise.
3. Improving manufacturing and services activities
The JPMorgan Global Composite PMI index has been rising since last four quarters and has been above 50 for the last two quarters, indicating a rise in global manufacturing and service activities.
JPMorgan Global Composite PMI
The Global Purchasing Managers’ Index (PMI) is a key metric in assessing a country’s economic health. It looks at the manufacturing and service sectors both, by surveying output and employment intentions of companies. A level above 50 indicates economic expansion, while a number below 50 indicates a contracting economy.
4. Short squeeze
Short positions are near all-time high since 2007, it can kickstart a fresh rally if we go by history. Except in 2007, such short levels in 2012, 2015, and 2020 led to big rallies. The reason for 2007 being an exception is that, during the other three times, the monetary policy was easy, whereas in 2007 the Fed was tightening monetary policy with rate hikes. This time fed is expected to go soft on rate hikes and is expected to even reduce rates in later half. If that happens, it can fuel this rally.
Data source of short positions:
The Commodity Futures Trading Commission’s (CFTC) weekly Commitments of Traders (COT) report provides a breakdown of the net positions for “non-commercial” (speculative) traders in U.S. futures markets. All data corresponds to positions held by participants primarily based in Chicago and New York futures markets. The Commitments of Traders report is considered an indicator for analyzing market sentiment and many speculative traders use the data to help them decide whether to take a long or short position. Commitments of Traders (COT) data is released each Friday at 3:30pm ET, pending a holiday in the U.S., to reflect the commitments of traders on the prior Tuesday.
5. Fed pivot
Higher interest rates are the root cause of current banking and housing sector crisis, both sectors are critical for economy and both are in bad shape. This situation puts pressure on Fed to reduce rates. Even if it pauses the rate hikes, that would be bullish for the stocks. U.S. economy is in a bad shape (see this – Global recession or a rally) – lower interest rates will boost growth.
CME FedWatch Tool
The table clearly shows that probabilities of Fed ease are rising.
About CME FedWatch Tool:
The tool allows users to calculate the likelihood of an upcoming Fed rate hike or cut.
The Federal Funds Rate is one of the most influential interest rates in the U.S. In order to hedge against or express a view on potential changes in short-term interest rates, market participants turn to 30-day Fed Fund Futures contracts. These contracts are listed monthly and are priced at 100 minus the expected fed funds rate. For example: If the current month’s contract is priced at 99, and the market expects the average federal funds effective rate during that month to be 1% (they would calculate 100 minus 99).
Using this information, CME Group created the FedWatch Tool. This tool acts as a barometer for market participants to gauge the markets expectation of potential changes to the fed funds target rate while assessing potential Fed movements around FOMC meetings.
Conclusion – It is a mini bull case:
2023 is coming out to be completely different from 2022, when barely any investments worked. Now the environment of scorching inflation and aggressive interest rate hikes is in the rear-view mirror. If corporate earnings stay good, this up-trend may continue for a while but do not expect a secular bull run. Inflation will be back.