We Rallied on Dismal News. I've Got an Idea Why

Sometimes the markets make us give a double-take. Last week was one of those times.

I for one am scratching my head.

Why? I had expected stocks would extend their gains on a slightly weak gross domestic product number. But I didn't think stocks could do as well as they did, on close to a -1% GDP print.

Let's try to sort out what happened here by revisiting the speech from the Federal Open Market Committee meeting and members' statements since, the larger political context of what's happening as well as earnings reactions and investor sentiment, and the way in which we can read the "data" that the Fed is saying it's so dependent on.

Let's start with the Fed. The actual transcript leans hawkish -- that I've concluded. Fed speakers since the FOMC meeting have skewed toward hawkish, too. Most notably, Minneapolis Fed Pres. Neel Kashkari went on national television on Sunday to hammer home the point. But, what have we seen so far? The markets don't seem to care. Did Fed Chair Jerome Powell sound more believable when talking dovish than hawkish? I see that. Also, is there a sense that politicians and the media are shifting their focus from inflation to the economy? I see that, too. Is the Fed interpreting "data dependent" as though it does not know what the data is going to be, but at the same time investors expect weak data? I see that, as well.

I can see why markets are treating the Fed as even more dovish than I thought they would, which is frustrating, because I am in the camp that the Fed is going to have to stop hiking sooner than later to focus attention on the economy. I kind of caught that shift, but not as well as I should have.

There are some heavyweights out there saying that we are nowhere close to the neutral rate. I think that argument is weak and will be ignored by the Fed. I only mention it, because I'm getting asked about neutral rates, and I think we have to be thinking long term, not just based on recent data.

One concern I have, going the other way, is that future inflation estimates, both market based and survey based are ticking higher again. The next round of survey based expectations could well go higher on the perception of a Fed pivot, which could bring out more hawkish rhetoric from the Fed.

I think the idea that Fed will save us, is overdone here.

Turning TINA

Now, let's turn to earnings, low yields, and sentiment -- mainly, the feeling of "there is no alternative" and, the investor favorite, FOMO, or fear of missing out.

We have so far had earnings good enough to prop up markets. I'm not sure that the earnings or guidance were quite as rosy as the market interpreted them, but they were more than enough to help propel stocks higher. There are two other things that I'm keeping a close eye on.

The first is lower yields are back to being good for stocks. Yields are going lower more because the economy is sending warning signs than because of Fed policy. I do not think that lower yields can continue to drive asset prices higher, but timing that reversal is tricky.

Second, are TINA (there is no alternative) and her good friend FOMO, making a comeback? Those are terms that I have not seen in a while that seem to be getting some traction -- at least as an excuse to buy into the rally of last week. Ethereum is up 60% or so in a couple of weeks. The most shorted stocks have outperformed recently. I'm not a big fan of TINA or FOMO, but I have to respect them in this market.

The rally seems overdone, but, It also feels like a runaway freight train, which you don't want to step in front of.

With the Volatility Index back close to 20, I'd rather buy some puts and calls and play for a big move either direction in the next month, than get too committed to one direction or the other.

The Stimulus Bill Effect

If the stimulus bill proposed by U.S. Sens. Joe Manchin of West Virginia and Charles Schumer of New York, both Democrats, gets traction, I want to buy the commodity complex.

Longer term, the bill might fight inflation, but near term it will pull demand forward for electric vehicles (inflationary) and will cause companies to spend to build out energy production capabilities (inflationary). Concrete, natural gas, silver, lithium, cobalt, and similar raw materials will all experience an increase in demand.

I want to add to the Energy Select Sector SPDR Fund (XLE) , the SPDR S&P Oil & Gas Exploration & Production (XOP) and SPDR S&P Metals & Mining ETF (XME) on weakness or if the bill looks like it will pass.

Yes, the more sustainable energy we get online, the better. It should be deflationary over time, assuming projects produce as much energy as hoped and costs and maintenance remain under control. Given what we've seen in Europe, however, keeping costs of maintenance controlled seems like a big if. On the other hand, it might even spur some companies to produce more today than they would otherwise, but I think the spending offsets create another tradeable rise in commodity prices.

Emerging markets, especially Latin America, should do well too if the bill gets traction.

Bottom Line

I see more risks to equities than positives, but momentum cannot be ignored, which stops me from being "pound the table" bearish.

I like taking some profits in yield products, especially rates products, as opposed to credit products, like the iShares 7-10 Year Treasury Bond ETF  (IEF) and iShares 20 Plus Year Treasury Bond ETF (TLT) for example as rate products, and iShares iBoxx $ Inv Grade Corporate Bond ETF (LQD) , VanEck Fallen Angel High Yield Bond ETF (ANGL) , VanEck Fallen Angel High Yield Bond ETF (FALN) as credit products). If stocks do turn lower, then it will be time to reduce credit risk exposure too (I'm looking to lighten up on some high yield and leveraged loan funds here, as they have had a nice jump in price/net asset value lately).

At the time of publication, Tchir had positions in XLE, XME, ANGL, FALN, SJNK, ILF.