Brace For Landing

Inflation is not dead, it's just late to the party. Today's 'miss' on the CPI is further evidence that the price stability we are seeking is a fleeting goal. Now that a soft landing has been pushed out further in time, the odds of a policy error have increased once again. Last week saw a textbook 'Tuesday at 11' rally, as the low level of investor sentiment combined with a crowded-short setup set the stage for a counter-trend bounce. The lower gasoline prices that were seized upon by rally-chasing investors acted like a conjurer's shiny coin trick - look here!

The real point of today's data is the sequencing of the increases. Goods prices started rallying late last year as the 'transitory' effects of Covid gave way to a more broadly based set of supply shocks, notably energy. And the precarious balance of energy supply and demand is still unsolved, despite the big drop since June. With OPEC no friend of the current administration and the SPR gambit now having been played, Biden is running out of pieces on that chess board.

The lagged effects now hitting core inflation are the most inelastic sources of price volatility. Shelter costs are rising still fast and there is no substitution effect available to ease the pain. Higher labour costs are just now being embedded into services prices. Health care and medical costs are similarly accelerating.

Just take airline ticket costs for example. My upcoming trip to Calgary is easily double the cost of last year. The juxtaposition of resilient post-Covid travel demand and the cost-push of fuel and labour has allowed the airlines to command enormous pricing power. The lags are obvious between the goods increase of last year and the service prices we are now seeing.

So again, like the July -August rally, markets have again jumped the gun. And since I never got the fat pitch from the VIX/VXV indicator, last week's bounce went by without any trade from the Tuesat11 portfolio. But the pullback today won't prompt any extreme risk-off bets from yours truly. As I argued last week the level of bearishness and the 'under-invested' stance of the average investment account argues for a possibility of a sharp rally at any time. But that time is not now. But it is closer than ever after today's knee-jerk selloff.

Some unpriced risks remain. QT is accelerating, sucking liquidity from the banking system. The inverted curve says it all. The market for fixed income is dysfunctional until a curve normalization is established. Either way that happens - likely now with a ten-year above 3.75% - is unequivocally bad for stock prices. But a sudden drop in the front end would be worse.

So a hard landing scenario has been put back on the table. But it is not inevitable. I continue to believe the Fed is using a flawed model that emphasizes trailing, domestic data. They are the defacto central bankers for the world, and that world is in rougher shape than they appreciate. But with their narrowly defined mandate, they can't help themselves. My message to the Fed is - "Get it over with!" Then we can really get behind this market.

Risk Model: 4/5 - Risk On

The sole bearish indicator is AAII sentiment this week. At some point, the model will be right. Stocks are neither oversold nor overbought. Gold is off more than Copper. The VXV is bouncing higher but not soaring above the highs of June. This is a Goldilocks reading if I have ever seen one. Buy and hold investors should stay the course. Traders should get ready to get long on bad news. Today is a good day to bottom fish. More bad days may come, but with the crowd now max-bearish, there is an upside pain trade staring us in the face.