Ian McAvity

GaveKal goes on to write about “Demand Pull” inflation, which is in high gear with the CPI for services (excluding energy) tagging +3.1% y/y, indicating consumers have the capacity to borrow more (see chart 1 on page 3). Moreover, the slack in the labor market is disappearing, suggesting wage growth should pick up. They also point out that the “cost drag” on inflation is easing with crude oil at $40 per barrel. Indeed, if oil prices stay at this level the rest of the year oil will be adding to, rather than subtracting from, our inflation rate. Finally, GaveKal surmises that the U.S. dollar has peaked, a point we have been making for roughly a year. As stated in last Friday’s Morning Tack:

For roughly a year I have suggested the Dollar Index was putting in a high and was going to weaken. I still feel that way and with the Fed's Wednesday dovish announcement the U.S. Dollar Index has broken down in the charts (chart 2). Now some will argue that the ‘trade weighted’ dollar is still climbing, but I have never seen a trade weighted dollar. You have never seen a trade weighted dollar. Go into your local bank and tell them you want to get some trade weighted dollars. Folks, we live in a nominal world and I think the ‘nominal’ stock market is going higher despite the fact all the sectors are overbought.

And, last Friday’s stock market responded with a Dow Wow of some 121 points capping a week where the senior index gained 2.26%. Not to be outdone, the S&P 500 (SPX/2049.58) broke above the often referenced 2000 – 2040 overhead resistance zone and in the process traveled above the downtrend line that has been intact since December of last year (chart 3 on page 4). The Weekly Win stretched the S&P 500’s winning streak to five weeks, causing my email box to fill up with the question, “Are we in a buying stampede and if so what is the day count?” Obviously we are in a “buying stampede” since the indices have not experienced more than three consecutive sessions on the downside. As for the “day count,” that stands at 25 sessions, implying it is probable stocks are due for at least a pause. Further, the 240-point pop (+13.3%) in the SPX from its February 11th low (of 1810) has left that index two standard deviations above its 50-day moving average for the most overbought reading in more than a year (chart 4). Likewise crude oil is overbought at the same two standard deviations above its respective 50-DMA. Yet, the commodity index looks to have begun a new bull market (chart 5 on page 5).

The call for this week: Over the weekend I heard a number of pundits talking about how expensive the SPX is at 17x this year’s consensus earnings estimate of ~$121. While it’s true the SPX is not trading below 15x earnings, like it was at the February 11th low, 17x doesn’t sound all that expensive to me. I would also remind participants the S&P 500’s bottom up, operating earnings estimate for 2017 is ~$137. If correct, that means the SPX is trading at 14.9x next year’s estimate. So earlier in these comments I stated that we live in a “nominal” world where “trade weighted” dollars do not exist, nor do “real interest rates” (inflation-adjusted interest rates). You and I have never seen a “real interest” rate; again, go to the bank and try to borrow money at a “real” interest rate. The bank will tell you, “What are to you talking about!” What is “real” is the nominal price of stocks and we think while a pause is due, the path of least resistance remains to the upside for stocks. This morning the preopening S&P 500 futures are relatively flat as President Obama meets with Raul Castro seeking economic and democratic reforms for Cuba. And that’s the way it is at session 26 in the current buying stampede. Stay tuned . . .

Jeffrey D. Saut is chief investment strategist at Raymond James.