It’s been several weeks since we last updated our near term outlook for the markets; here, here, and here. We expressed a generally bullish view on stocks, bonds, and gold, largely on a generally bearish turn for the dollar. But not without an expiration date, for example:

”The combination of favorable seasonals and a completed inverse head and shoulder pattern in VT suggests further rally potential in stocks, albeit at a less breakneck pace, for the remainder of the year. This is further supported by today’s broad participation, where small stocks actually left the teracap techs in the dust, with the Russell 2000 up a smashing 5.49% versus the Mag 7 at 2.30%. Until the inflation feeds through to consumer prices, asset prices are free to rise unconstrained. After that the picture grows more tempered, as the inflationary impulse matures and the specter of further rate hikes resurfaces or the paint finally dries on the Fed’s shrinking balance sheet. Until shown otherwise, the broader bear market remains in effect; at this point a more volatile 2024 Q1 looks likely.

Bonds have completed a full five waves down in Elliott Wave terms. That implies substantial further upside after this grizzly bear market. While bonds and stocks have remained highly correlated longer than I have expected, a decoupling will still be necessary to complete the cycle.”

Markets have since performed largely as expected. Bonds and stocks have rallied sharply, and small cap stocks especially have left their large cap kin, including the storied Mag 7, in the dust. But these macro trends are now overextended, and we’re at the cusp of a turn in the calendar that will likely see them turn as well. The final trading days of 2023 brought us a bit of a preview for early 2024.

The narrative behind the bearish dollar and bullish action in most everything else – at least as denominated in dollars – is the financial media’s rush to embrace the long anticipated Fed Pivot. Inflation has been vanquished, the story goes, and the Fed will soon be slashing short term interest rates, if only to keep them from rising in real terms as inflation declines. The trouble with this spin is that it’s based on badly lagging inflation data. Consumer prices, and the measures that follow them, particularly CPI & PCE, whether “headline”, “core”, “supercore”, or other economic fiction, track not inflation but its exhaust fumes. The dollar depreciation seen in real time markets, foreign exchange, bonds, stocks, and commodities, is where it’s seen first.

And short term interest rates live first in the capital markets. So long as inflation is roaring there, “real” short rates remain low.

The Powell Pivot added some twenty trillion dollars of market cap to global stock and bond markets. Since it created no new goods and services, that gain in purchasing power must have come at the expense of losses in other securities; currencies, especially dollars, and if not soon reversed is destined to show up in consumer prices in the coming quarters.

At least some of it likely will be reversed. The bulls’ rush to front run the Fed is their own worst enemy. Having already priced in interest rate cuts, nothing is left to price in once they actually occur. Nothing truly new here, though, hence the Wall Street cliche “buy the rumor, sell the news”.

The picture is complicated by more conventional econometric data such as employment. Unemployment has begun to creep higher. And one of the most economically sensitive physical commodities, oil, has diverged from the rest, being notably weak, even in comparison with Doctor Copper, with whom it usually concurs.

So we’re hardly suggesting the rate cuts won’t come. On the contrary, they’re already established fact where it counts most … the bond market. The Fed itself is a lagging indicator. The bulls’ problem is their failure to account for what conditions will pave the way.

So putting all this together, the looming threat is a combination of a weakening employment market at the same time consumer inflation is poised to resurge. This is often referred to as “stagflation”. Financology however eschews the term, as it implies that simultaneous economic weakness and inflation is unusual enough to warrant its own name. It’s normal. Looked at without the artificial effect introduced by adjusting GDP with lagging inflation data, inflation is more accurately seen as contributing to, if not causing, economic weakness, especially if economic weakness is identified with broadly stagnating if not declining living standards.

Not to mention inflation is the first resort of governments trying to recreate the appearance of the prosperity their meddling has destroyed.

But here we’re concerned with financial market prospects. This cocktail is consistent with weakness across asset classes, but more so with stocks than with bonds. In fact a selloff in the stock market is the likely catalyst for the Fed rate cuts the bond market already prefigures. Sorry Wall Street, the rate cuts that you’re basing runaway stock price inflation on are will require stock price deflation to come first.

The only alternative is resurgent consumer price inflation resurges without bound.

Gold prices could powerfully benefit. Normally easy money can just as easily float stock prices as gold, but economic weakness drives in a wedge that channels the price largess in gold’s favor. Only when the markets begin to see “green shoots” does the easy money favor stocks.