Wednesday's Market Minute: Careful On That Trampoline

The biggest surprise to everyone is just how well the economy is doing. It's probably the most shocking economic event since the initial Covid panic. By comparison, the summer 2020 bounceback of the quarantine economy was an eye-opener, but far from shocking, given the role that big-tech products play in the economy. This one, on the other hand, almost nobody saw coming.

The clues really added up by the last week of June when durable goods, housing and confidence came in surprisingly strong. It was then that I offered a moniker for the possibility of a big economic bounce-back: The Trampoline Landing, a more specific alternative to the polarized hard and soft landings that were the bear and bull case, respectively. That was this column on Thursday, June 28th. A month later, the 10-year yield broke back through 4% and the S&P 500 peaked.

It's no mystery why stocks are down off their highs since: treasury yields are up. A lot. But they're going up in a very different way this time, in fact almost the exact opposite of what they did last year. That's what's so fun about the bond market: on the surface you see the exact same ripple, but the beast underneath is completely different. That's what we're trying to figure out right now: what is the impact of the nominal interest rate versus the speed at which it moves? 

This is the great higher-for-longer conundrum, and we don't have a great answer yet. We moved really fast and we blew through crucial levels the past 3 months so it's hard to know which one stocks had a problem with. There are plenty of examples in history where stocks and yields go up together but unfortunately none that occurred after our great experimentation with the zero bound. When you are dividing by zero, you're in a new territory, where rates of change do not theoretically exist. So far one thing seems clear: stocks have been unable to differentiate between a steepening yield curve and a flattening curve -- events whose economic implications couldn't be more different -- and that means equities are probably overvalued no matter what happens.

Chalk it up to stimmy blood still running through our veins, a robust labor market, unending deficit spending, or maybe just a darn good steward of the economy in Jerome Powell, what matters is it looks like we still have runway ahead of us for a standard landing. PMIs are all back over 50, GDP is set to breach 4%, and retail sales are chugging along happy as ever.

So what's underpriced? The consensus seems to be that the economy will remain firm, but inflation will too. Then there's a loud but growing minority that believes inflation will stay high while the economy crashes. It seems the thing we're now least prepared for is if the economy booms further but inflation keeps cooling. For stock bulls, such a dream case may just be the only out.

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