It was a rough week for market pessimists as the market ignored a hawkish Fed and a red hot employment number and refused to give back recent gains. Robust action moved under the surface, as well, as small caps and biotechnology outperformed.
What was most interesting about the action this week was that several Fed members made it clear that the Fed is not likely to pivot any time soon. They walked back some of the dovish signals that Fed Chair Jerome Powell issued that helped to get this market running, but it didn't generate a negative reaction.
The most likely reason for this action is that there is very poor positioning. After the miserable market so far this year, many investors are sitting on high levels of cash, and they are growing concerned that the market is going to run away to the upside without them. Throw in some shorts that are forced to cover and fear of missing out, and we have the recipe for some very lopsided action to the upside, regardless of the macro-economic situation.
The strong employment report on Friday could have easily been used as an excuse for a selloff, as it is inflationary and will keep the Fed hawkish for a longer period, but the market shrugged it off and embraced the narrative that the economy is so strong that the Fed can raise rates and it still wants to cause a recession.
I don't know if that is true or not, but it was the theory that was embraced and prevented a selloff to end the week.
Next week we have another important economic report on Wednesday morning when the consumer price index is reported. This will be a market mover and is especially important, since the bulls are now embracing the narrative that inflation has peaked and is dropping quickly. If the CPI comes in hotter than expected, it is going to surprise quite a few folks that have been buying this week.
We have extremely unusual market conditions as we deal with inflation, a slowing economy, and a hawkish Fed. The interrelationship between those factors is causing a great amount of uncertainty and poor positioning. Simple logic will not work very well in this environment, but there is no shortage of folks who are confident that they know where this market is heading.
The good news is that we are very likely to see some increased volatility as conditions develop further. I don't know what will happen, but I'm sure there will be many good trades along the way.
Have a great weekend. I'll see you on Monday.