Blame The Weather, Then Blame The War – Lower Expectations, Higher S&P 500

The world has caught on the game and even central banks are long equities. Life is all about expectations and meeting them. When your expectations are low, you will always be happy and if your expectations are not met, you blame something and push your expectations into the future. That is the beauty of faith and hope.

Rosy outlook = higher prices due to economic growth
Lower reality = higher prices due to extended stimulus
Lower outlook = higher price due to extended stimulus
Higher reality = higher price due to economic growth

Why is the stock market so resilient ?

1. Companies are buying back stock because
– they are not so bullish on the economic outlook ?
– cheap funding ?
2. Central banks are buying stock in record amounts.
3. Economic forecasts are always rosy
Paul Krugman pointed this out, WSJ pointed it out too.

taken from NYTimes Opinion pages.

There is a certain conflict of interest there with central banks being long equity, their stimulus measures and their economic and inflation outlooks.

The economic outlook must always be GOOD otherwise it is a sign that their policies are not working.

Revisions are then BLAMED on Q1 – the polar vortex and for Q2 – Ukraine, Syria and luckily, Iraq.

The World Bank has already slashed their outlook for the world, after IMF’s admission they were too pessimistic on UK last year. The moral of the story being, its better to be wrong about pessimism than overly optimistic if you are not in charge of the monetary policy or the weather or wars.

What about inflation ?

In a paper published by the Fed, the “low rates set by the Fed could actually be contributing to low inflation and low inflation expectations” if we apply Irving Fisher’s equation : nominal interest rate = real interest rate + expected inflation rate .

There is a potential for a loss of credibility if the low interest rates cascade into a deflationary spiral and we end up with a lost decade ahead of us. Although the reasonable expectation will be that “Fed is successful in engineering a recovery with a gradual rise in interest rates. Interest rates rise enough to prevent a loss of credibility, but not so much as to cause another recession ” which sounds like a superhuman balancing act.

But we will have none of that for Q2, because we are lucky to have the wars to blame to postpone our expectations for another 3 months.

Even Dubai shares are rebounding higher by 4.8% as I type after the stock market rout wiped out some 7% from the Dubai Financial Market General Index yesterday (it was up 51% for 2014).

Tonight we have the third US GDP reading for Q1 where expectations are that worse numbers will be reported which is good again for stocks, especially if the numbers surprise to the upside.

Expectations are made according to the “its better to be wrong about pessimism than overly optimistic if you are not in charge of the monetary policy or the weather or wars” theory.

In the days ahead into month end and the half yearly closing, funds will be rebalancing their portfolios and making provisions/adjustments for fund flows which means they may have to liquidate the highly profitable positions as customers take profit.

Following into July, we will have the earnings season where Reality Strikes and Bites.

Earnings estimates are also subject to the “its better to be wrong about pessimism than overly optimistic if you are not in charge of the monetary policy or weather or wars” which means it should technically be bullish for the market.

With the central bank revising growth lower, expectations can lowered further without affecting the stock prices because bonds yields are doing far worse.

Thus it should not be unreasonable to expect another surge of the S&P index to lofty new highs ? as we push our expectations for a better results into the future with the good reasons of the weather and war and hopefully a new blame in the months ahead which is not difficult to source – the Ebola outbreak has gone out of control ? or more weather – El Nino ?

I am not sure when faith and hope will run out, but I think the curtain call for mid year is also timely reminder of the fabulous rally we have enjoyed since May’s FOMC meeting and a good excuse for a correction has arisen.

The S&P has held above 1900 for 2 months now and most analysts (60% according to Investors Intelligence) are bullish for a test of 2,000.

A test of 1900 would get people analysing again without ruffling the central banks’ longs.