The short-term resolution to Washington’s folly ignited stocks last week, kicking off what looks to be an equity overshoot phase. Even a soft earnings season is unlikely to derail the budding positive momentum in the broad market: investors may award a ‘free pass’ to the business sector, as uncertainty and modest order book softness is expected given the U.S. government shenanigans.
More importantly, lost in the shuffle has been the simultaneous easing in three main reflationary variables.
First, the U.S. dollar is drifting lower, reflecting the official nomination of noted policy dove Janet Yellen as the new Fed Chairperson, and the expectation that liquidity settings will remain extremely generous.
Second, Treasury yields are moving sideways, digesting this year’s rapid advance. Prospects for another budget battle in the coming months suggest that the Fed may well delay tapering further. Thus, another sudden surge in yields is not imminent.
Third, oil prices are easing, reducing a drain on global consumer and business purchasing power, especially in the developing world where weak currencies have exacerbated the impact.
The reflationary push from these three natural economic stabilizers will add to the positive economic momentum that has been slowly but steadily building all year. Our profit model has hooked back up, and capital spending indicators are accelerating, implying that the transition to a self-reinforcing economic expansion remains intact. With reduced fiscal drag next year, growth could surprise on the strong side.
Bottom Line: An extended period of flush monetary conditions amidst a non-inflationary economic expansion will sustain the positive cyclical equity backdrop.
