Here Comes Deflation
We are at that point in the cycle in which lagged economic signals show lingering end of cycle inflation mixed in with widely ignored signs of impending economic collapse. The most dangerous point in the cycle...
Yesterday we learned that three year inflation expectations are at a decade low:
Stocks ended yesterday flat, but breadth was negative all day on both exchanges. The Dow was red all day. Today (Tuesday morning) PPI came in weaker than expected. So far, the initial reaction in the stock market is for a rally, however I predict that breadth will turn negative again this morning.
Once again, this comes down to positioning because ever since Tech stocks rolled over in July following their massive melt-up first half, investors have been positioned inversely wrong relative to what is taking place in the economy. Yes, there was a massive rotation out of Tech, as most pundits expected. However, where they went wrong is in believing that Fed rate cuts would continue to be beneficial to the stock market which was the hypothesis behind the entire Tech/AI rally. Unfortunately, Fed rate cuts and a weaker economy WILL NOT benefit the other "493" S&P 500 stocks which are struggling to lead the market.
Below we see bank stocks with bond yields as exhibit A of what I am talking about. During the big rotation banks ramped higher but bond yields rolled over, in a major divergence. For a time, banks ignored imploding interest rates. But then last week bank stocks collapsed lower. This same chart can be seen in small caps, EM stocks, Industrials, Retail, Transports etc. All of the cyclical stocks are getting monkey hammered by weak economic data.
Clearly, investors have already forgotten what happened two weeks ago when the jobs report came out weaker than expected. Normally that would have been a catalyst for a rally, but that is when BOTH the stock market and the Yen carry trade exploded. Now in this close-up view what we see is that stocks, the Yen (inverse), and bond yields are now highly correlated and heading down in unison.
It's only a matter of time (CPI tomorrow?) before the next explosion lower takes place.
Which is why I find headlines like this one that came out this morning to be funny:
"Wholesale prices came in lighter than expected for July, a hopeful sign for consumer inflation and Federal Reserve rate cuts"
As I pointed out on Twitter, after the DotCom bubble burst, rates fell -5% and stocks fell -50%. During that time there was a massive rotation out of Tech stocks into the rest of the market, but that rotation didn't save the major indices.
Another fact I would point out in this chart is that this is the exact same duration of time that the Fed rate was paused as occurred during the rate pause of 2007 i.e. one full year. After that, when the Fed started easing, stocks rolled over.
In summary, investors have rotated into cyclical stocks at the end of the cycle. They now own the stocks that perform worst during recession. And if they had even the slightest clue about economics they would stop cheering for rate cuts.
