MorningWord 2/6/15: The Path of Least Resistance Remains… UP

by Dan February 6, 2015 9:22 am • FREE ACCESS

It’s my view that there is a lack leadership in the U.S. equity market, at least from the sectors that we would generally associate with strong economic cycle. This is not an overwhelmingly bearish observation. It merely means that if the market is to breakout of the 100 point range it has been in since early November there will need to be other sectors, aside from those perceived to be defensive groups to grab the baton. Because while not being bearish, it’s not particularly bullish that the best performers year to date, and for the better part of the last year have been defensive in nature, like Utilities, Healthcare and Staples, representing either caution and/or desire for yield:

From SeekingAlpha
From SeekingAlpha

This morning’s better than expected January Jobs data, coupled with a large revision higher for December clearly speaks to an improving economy, yet we may find ourselves in an odd scenario where good data leads to a more hawkish Fed that could lead to sooner than expected rate increases halting the recent economic progress.  The Fed will remain “data dependent” on their zero rate policy, so investors should continue to track how stocks and bonds react to better than expected economic news as I suspect at some point if yields start to rise on their own that there would be a reflex action in the equity markets.  I know, I know, where can U.S. yields go when the differential between European Sovereigns are so dramatic? It just sounds counter-intuitive that our Fed can sit by with hot economic data and not move a muscle, as they risk inflating a risk asset bubble if the data continues in this direction with inaction on rates. If that’s the case there will be no other choice but to go all in on U.S. stocks as it would look like the late 90’s.

Which brings me to the chart of the S&P500 (SPX). It looks to be about one more headline from the previous all time highs:

SPX 1yr chart from Bloomberg
SPX 1yr chart from Bloomberg

If we were to see a rotation out of defensive sectors, if energy related stocks were to at least stabilize and maybe even re-trace a bit of the recent decline, if bank stocks were to get a second wind from the potential for higher rates, industrials to shake off EM and low oil concerns and Technology to get back on its horse, then the SPX could be on the cusp of having a sort of Disney (DIS) moment. Translation, an epic breakout to new all time highs after a long consolidation:

DIS 1yr chart from Bloomberg
DIS 1yr chart from Bloomberg

Of course that’s not the only scenario. Anything can happen as far as China and Europe and if things get weird overseas there’s probably little the Fed can do about it here. But the longer the Fed stays dovish the more likely it is that we see some late 90’s style silliness in U.S. equities.

This is not a prediction, and frankly I am not positioned for this outcome. I remain cautious about committing new capital to equities, but the path of least resistance appears to remain UP. And defined risk bets in options playing for breakouts is probably a lot safer than just diving and getting balls long.