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There are, no doubt, many ways to get the clear impression that one has been spending too much energy contemplating market scenarios, while also spending too many hours on bar stools.
The latest such revelation came to me last week, upon seeing this graphic late Tuesday on a barroom television: "Hawks/Bulls: Wake up call for the Bulls or something more?" My first interpretation of that line was that it was asking whether fiscal/monetary/inflation hawks had finally gotten the attention of the "risk asset" bulls, and whether those collective concerns were causing some softening of the stock and commodity markets. In fact, the graphic was about the Atlanta Hawks/Chicago Bulls basketball playoff. Nonetheless, it neatly captures the consensus take on Wall Street in recent months that the main risk to the bull market in riskier, cyclically geared paper and real assets is a less generous, more hawkish approach by the money printers.
The idea of a "QE2 cliff" -- the moment of asset-market reckoning around June 30 when the Federal Reserve's bond-buying program is due to cease–has been rampant, even though the program has been vilified, as well as embraced, on the Street. This is reminiscent of the sentiment entering 2010, when the chief market risk was popularly deemed to be the central bank's turning less generous.
Both then and now, as suggested by the market action recently and last year, there has not been a tight cinching-up of monetary policy, but rather a garden-variety slackening of U.S. economic momentum.
In both instances, most of what an open-minded and risk-conscious investor needed to heed could be found in the Citigroup U.S. Economic Surprise Index, a measure of how much better or worse the official macro data are, relative to the consensus forecasts. This has recently weakened as the data have trailed forecasts (as the data did a year ago), even considering the better-than-handicapped employment figures Friday.
This, along with some crowded and overconfident positioning in a few asset plays -- such as long silver and other metals, short the U.S. dollar and under-investment in Treasury bonds -- explains most of the stock- and commodity-market indigestion of last week, when the broad domestic stock market slid 2% and commodities suffered deep losses.
At this stage of the cycle, it's not a less spendthrift Fed or gently rising interest rates, but hints of stalling economic growth, that pose the greatest threat. Indeed, longer-term bulls on stocks should wish for the circumstances that would nudge both Treasury yields and the dollar higher.
If, as seems quite possible, the rise in gasoline prices and heaviness in global copper prices are suggesting a period of choppy macro data, stocks could be in a range-bound, churning, wheat-versus-chaff stock-picking period for a while. This notion is supported by the perception that there's probably a bit more investor enthusiasm to be worked off. In addition, more companies (including the Swiss commodity-trading firm Glencore) have recently filed to go public than one would prefer to see.
The Ned Davis Research "cycle composite" chart, cited here occasionally, combines the historical stock-market tendencies of the 10-year cycle, the four-year presidential-election cycle and the annual seasonal trajectory. It now hints that the upside could be capped for a while and that some backsliding should be expected over the summer, but that higher levels should be hit by year's end. This conforms with the view of chart-reading forecasters, who are leaning on the rally's still-sturdy breadth, the leadership by smaller and more cyclical stocks and the positive trend indicators, most coalescing around S&P 500 targets above 1400. That benchmark is now at 1340.
This remains plausible, given that the stock market is an instrument for capitalizing the profit stream of large, substantially global companies, and not the mood or well being of the typical survey-answering household.
In addition to the usual economic data, the credit markets should be watched for signs that the recent pullback is more than a prosaic resetting of equity values and investor expectations. So far, credit markets have held firm in the commodity spill and equity retreat. As Abdullah Karatash, head of U.S. fixed-income trading at Natixis note, "The corporate bond market will be stress-tested next week with new-issue volumes expected to be very high."
The results of that test should surrender some clues about the underlying strength of a stock market that is mostly being whipped around by external forces. And it wouldn't hurt to monitor the Hawks-Bulls series, which was tied 1-1 entering Friday night's game, as Barron's went to press.
E-mail: michael.santoli@barrons.com
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