It seems that the market is in a precarious position. After a few months of very weak trading, we have experienced a fairly significant 10% bounce off of the lows and now the S&P 500 sits within a few points of June highs. The positive price action stems from decent corporate earnings results and outlooks, short covering, a bounce in the Euro, and the release of European bank stress tests (for whatever they are worth).
Some other positive data items for the return of the “risk trade” are a falling dollar, rising AUD, mostly rising commodities and a very weak VIX.
On the flip side of this risk trade is the fact that interest rates remain stubbornly low:
In addition to low treasury rates, there are a few leading indicators that are a bit troublesome. Most have been touting the absolute proof of a double dip recession based upon the Economic Cycle Research Institute’s Leading Indicator’s negative growth rate of -10.5%:
As with all signals, nothing is perfect. The ECRI has gone negative before without recessions, but the research institute is fast to explain away all false readings. I suggest you pick up their book to figure out how they suggest that you use their tools. I am sure that if we did experience a double dip, then the institute would be quick to claim that they predicted it.
What had me a bit concerned today was a rather weak reading from the Chicago Fed National Activity Index. The index has a lot of noise in its data, but the sharp downturn does not leave you with a lot of comfort:
So what does it all mean? As I have said in the past, either equity markets and the underlying corporations are too euphoric or the bond market has it all wrong. Today, new issue Kimberly-Clark (KMB) 10 year corporate bonds priced at about a 3.65% yield while their stock pays a 4.12% dividend yield. Something is not quite right with that picture. This dilemma lies at the heart of the inflationist/deflationist battle. Either the equity is attractive, the bonds are very rich, or maybe there is a sweet spot in-between. If we can believe in a stable economy going forward, without revisiting a strong downturn, then the stock is most likely cheap and the underlying 10 year interest rate is too low. If the treasury rates and the economic indicators point to a double dip, then a full force of deflation is on us and look out for Quantitative Easing 2.0. Either you can pick your side or watch from the sidelines.