Another Brick in the Wall

A newly cemented brick has been added to the wall of worry. Short-term rates are now rising. But that's not gonna stop the bull market.

As I postulated in "Bad News, Bears" two weeks ago, the much-anticipated stock correction has now been avoided by a reassuring rate hike. I wrote:

"So what if the Fed gets a strong inflation print this week? The vote to hike, obviously. And the speculative positioning covers their bets, thereby producing a curve-flattening bounce in the bond market. The release of pressure on stocks will mean an instant rally in that market."

The reassurance that the Fed isn't beholden to Donald Trump, combined with the removal of policy uncertainty, has given the market new life. Trump's feeble attempt to scapegoat the FOMC has backfired, allowing Warsh to restore confidence in the Fed's credibility. Stocks are still in the driver's seat as earnings expectations continue to rise and PE multiples have contracted. The large-cap growth momentum trade is not done just yet.

Just look at where AAII Bullish Sentiment is:

AAII Bullish %

Other than the "Liberation Day" lows last year, this is the lowest level of bullishness of the past 12 months. The contrarian in me is getting bullish. But the newest brick in the wall - rising rates - isn't yet an existential threat to the bull case. You need a series of hikes and an inverted curve for that. And with a 6% nominal GDP growth rate, 2% productivity increase, 3% inflation, and 4% unemployment, these interest rate levels are normal. Financial conditions are like the third bowl of porridge - just right.

So the next bearish narrative in the wall of worry that markets must overcome is literally 'existential' - as in the possibility that AI will cause human extinction if it isn't curtailed. Analyzing that is, by definition, above everyone's pay grade, so I'm not even going to try. But investors have to deal with that uncertainty before the AI trade can regain its lost leadership. Over to you, tech bros, give us some guardrails please!

The rising cost of diesel will continue to pressure consumer prices now that Ukrainian drone warfare has decimated Russia's exports of that crucial transportation fuel.

And I can't feel totally comfortable with risk assets given the looming midterm elections. The Trumpian forces of evil are hard at work trying to circumvent the democratic process as the election approaches. Not a confidence-enhancing backdrop for investors in U.S. dollar-based assets.

They're just more examples of bricks to be added to build a wall for the stock market to climb.

But climb it we must.

I'm still worried, so that must mean this sideways correction is almost over. The risk of a major sell-off has been averted. I'd be a buyer of any dips now.

Risk Model: 3/5 - Risk On

Despite the bearish posture of the AAII crowd, the 'fear gauge" has stopped dead in its tracks, failing to give us a sell signal as it remains below the 100-day moving average.

3-Month VIX

As well, there is a washout in the breadth measure that I watch, indicating a good entry point for risk assets. The percent of stocks below their 50-day moving average is approaching levels commensurate with previous tradable lows for the S&P 500. After today's bounce runs out of steam, a retest or unconfirmed new low that brings this measure to below 25% would be the time to get more aggressive.

S&P500 %Above 50 DMA