Right now, there are two distinct views
On prices and markets and news
For bulls it’s a time
For rapture sublime
While bears are all singing the blues

But there are still those who believe
The bullish view’s naught but naïve
Inflation’s not dead
And looking ahead
The bulls will have reason to grieve

As it is a US market holiday, with no equity or bond market trading, today’s observations will be brief.  While there are always two sides to the market story, I find that the recent gap between views is remarkably wide.  Perhaps this is because after more than a decade of ultralow interest rates, where whether one was bullish or bearish, the outcomes didn’t seem dramatically different, we are now in a situation where interest rates enter into investment decisions in a far more impactful manner.

Arguably, everything starts with the Fed, as well as its brethren central banks.  And this is the first place where opinions are so widely varied.  There is a growing camp that is certain that the Fed did not merely skip hiking rates last week while they observe the data, but that the rate hiking cycle is over.  This view is based on the strong belief that inflation is over, it is trending lower and that by the end of the year, not only will headline inflation be 2% or lower, but that core CPI will be following it down as well.  If this is your underlying belief set, it is easy to understand why you would be bullish on risk assets going forward.

The sequence goes something like this: tepid economic growth => rapidly falling inflation => end of Fed hiking cycle with eventual pivot to cuts => equity markets anticipating lower rates and growth rebound => Buy Stonks! 

Certainly, tepid economic growth seems to be the only part of the narrative that is widely accepted.  However, it is the inflation piece where different views start to drive the separation between camps.  Headline CPI (and likely PCE next week) has been falling on the back of the decline in energy and food prices compared with the immediate post Ukraine invasion situation.  The bullish argument also relies on the idea that due to the BLS methodology of incorporating housing inflation into its data with a significant lag, that the core number is going to start to decline sharply as well.  And it is this piece of the puzzle that is far harder to accept as a given. 

Thus far, there has been little to no evidence that core CPI is declining rapidly, in fact it is not declining at all and has been running around 5+% for a year now.  Perhaps wage pressures will collapse and eventually service prices will fall, but there is no evidence of that yet.  Perhaps home prices will fall sharply across the country, but there is no evidence of that either.  Rather, there are pockets of strength and pockets of weakness, but the overall data continues to show slow gains in prices.  As to straight rents (not OER), again, with Unemployment remaining low and wage gains evident, why is there a strong belief that rents are going to fall?  But all of this is part of the bull case, inflation is over, deflation is coming and the Fed is going to cut rates.  Oh yeah, AI!  AI is going to drive equity market values higher forever!

At the same time, the bear case essentially disagrees with the inflation collapsing thesis and points to the fact that the entire equity market rally this year has been on the narrowest breadth in history, with just 7  stocks accounting for the entire gain of the S&P 500.  So, 493 of the 500 companies are essentially unchanged on the year while 7 have had outsized gains and that is the definition of a bull market.  In the past, when market breadth had narrowed to levels currently seen, there has always been a retracement.  This is not to say that we are about to turn lower starting tomorrow (although risk was clearly off in the overnight session and in Europe as I type), but unless one is willing to believe that the entire economy will be driven by 7 companies going forward, changes seem likely.  And those changes mean repricing those seven leading companies lower.

Add to this view the idea that inflation will remain far stickier than the bullish narrative which means that interest rates are going to remain higher for longer (just like the Fed has explained) and having a bearish view is easier to understand.  Remember, too, there are a large percentage of companies in the S&P 500, something like 100 or so, that are zombies, defined as companies whose cash flows doesn’t cover their debt service and so they need to constantly borrow more to stay afloat.  There have already been more than 230 bankruptcies of companies with >$50 million in liabilities through the first four months of the year, a record pace.  Some are quite well-known, like Bed Bath & Beyond, and many are less famous.  But given T-bill yields are above 5%, there is much less search for yield and junk names have to pay a lot more for their funding.  Many of them will not be able to afford the new funding levels and will follow BB&B into bankruptcy.  This is not a bullish take.

So, that’s what we have, a growing gap between the bulls and the bears, with each side looking at the same data and seeing completely different things. (Sounds a lot like politics these days!)  Personally, I fall on the bearish side of the line, but you probably already knew that.  As time passes, I expect that we will see far less indication that inflation is over, and at some point, there will be capitulation.  But right now, the following graphic from CNN tells the story:

Good luck

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