How Markets Digest "Good News"

I concur with the below from BCA… And I’ll add that the setup described leads to a surprisingly broad misunderstanding among market participants about the interaction between economic conditions and markets… I.e., good economic news can be (often is) bad news for stocks based on what it portends for market-based interest rates and for go-forward monetary policy – particularly in an "inflation focused" environment. 

On the flipside, good news is good news typically when we’re earlier in the cycle -- when earnings expectations are less-robust and rates are not near cycle highs; which is clearly not today.

Notwithstanding -- per the last paragraph from me below -- the likely good-news-boost we'd see were the strait to open tomorrow (since, for the moment, geopolitics utterly dominates market sentiment)... Case in point the market bump that just occurred, literally a I type, on the following headline:   stocks middle panel

BCA:

"Back To The Upside Down?

The Iran war has made inflation the market’s main focus again, creating a backdrop where resilient data could hurt equities. Long-term inflation expectations remain anchored, but the near-term inflation path is still uncertain. Markets are still trying to gauge how large the next inflation wave will be. So far, the data show inflation steadily rising.

That changes how markets react to macro data. In a growth-focused environment, stocks and yields usually move together. In an inflation-focused environment, they often move in opposite directions. The same reversal applies to economic surprises. In a normal backdrop, stronger growth data are good news. In an inflationary backdrop, stronger growth data can become bad news because they point to tighter policy. Weaker growth data then become good news because they imply less inflation and less policy drag down the line.

The Iran war began in early March. Economic surprises moved sideways through March, before the March data were published in April. Since then, US data have proved more resilient than expected, and surprises have rebounded through May. This helps explain why bond yields have risen in recent weeks, as growth and inflation have both held up better than when cuts were priced. The next few weeks could therefore produce odd price action, with resilience itself becoming a risk for equities. Paradoxically, the recent tightening in financial conditions will weigh on future economic surprises, which should help limit the damage to risk assets. "

I made the case heading into this year that, while we were (and, for now, remain relatively) constructive on equities, the pending fiscal oomph and its attendant animal spirits among consumers and traders could be the makings of a 2022 scenario, where stocks ultimately tank on the prospects for higher inflation and interest rates… And now, while the Iran conflict poses a potentially-serious headwind for the economy, the nature of the headwind (higher energy prices) poses a serious problem for a Fed that would otherwise provide a monetary tailwind.

Not that we won’t see the anticipated rip-your-face-off rally should the strait open tomorrow, I’m talking later in the year, when, should geopolitical headwinds abate and animal spirits ignite, those inflation chickens come home to roost.

One more from BCA:

"Is Resilience A Risk?

We stay tactically open to further risk-asset upside, especially if Hormuz improves, but recognize that the 6-12 month setup is becoming more dangerous. Our monthly BCA Views Meeting centered on the tension between near-term resilience and medium-term vulnerability. The global economy has absorbed the oil shock better than feared, helped by elevated inventories, reduced Asian crude imports, rationing measures, and US inventory drawdowns. But those buffers are temporary, and the oil market should become more exposed to a tighter supply-demand balance by mid-year.

A key risk is that resilience itself becomes inflationary. If demand does not weaken enough to offset higher energy prices, oil could begin feeding stickier inflation expectations. That would leave the Fed in a difficult position: Hike and pressure equities, or resist hiking and risk a further bond-market selloff. This matters because equity gains have relied heavily on AI, PE expansion, and confidence that rates will not become a major headwind.

Our strategists remain more constructive tactically than cyclically. A near-term Hormuz resolution could extend the rally, but the 6-12 month outlook is deteriorating as inventories fall, inflation risks rise, and higher capital costs become more relevant for the AI CapEx boom..."