Summary

As you know, we have postulated for almost two years that we were in a holding pattern for stocks. November has shown some promise in breaking out of that slump but there are still some key segments of the market that are struggling to break out to new highs - those being Transports and small caps. If you have been reading along you know that we see the breakout of these two segments of the market to be the key to divining if this break out is real.

While I am cautiously optimistic about near-term prospects for the equity market, those feelings are equally tempered by how late in the cycle we are for the economy and stocks. We are currently in the tenth year of what usually is a 7-year bull market. This bull market is currently the longest on record and valuations are stretched historically. The fear of a recession on the horizon is real as the latest numbers from the Atlanta Fed see Q4's GDP looking around 1%. I believe that any recession in the US is still two or three quarters but we continue to be underweight equities. We still see risk asymmetrically skewed to the downside. We dare not go even more underweight should the Fed engineer a soft landing (or see a Trump payroll cut in 2020) and see equities run higher. In essence, we are trying to have our cake and eat it too. While prepared for a recession on the horizon and attendant stock sell-off, we will still be adding to our capital gains should stocks continue to push higher.

It is really hard to buy into this latest rally. S&P earnings are negative year over year for the past 3 quarters yet valuations continue to not only hold on, but grind higher in the case of the S&P 500. While we look under the hood of the market and see that important bellwethers of the economy are lagging, in the manner of small caps and transportation stocks, you can also see that earnings growth is not driving the stock market higher, it is the most recent liquidity injection from the Federal Reserve and continued massive buybacks from corporate America.

The really big market mover recently may be Jerome Powell's comments that he is willing to let inflation run.

"I think we would need to see a really significant move up in inflation that's persistent before we even consider raising rates to address inflation concerns." - Jerome Powell 10/30/2019

The words really significant may be what has led to the turn higher in stocks and bond yields.

As we look to the next decade for investing, the most overriding issue has to be the inflation/deflation debate. The biggest winner in an inflationary scenario will be the biggest debtor. The biggest debtors are governments. Remember - the Fed wants inflation and needs inflation. There is no other way to pay back all of this government debt. It must be inflated away.

Things must be getting serious if Terry is putting charts in the blog this week.

This chart courtesy of Bloomberg shows the steepening of the yield curve before the last two recessions. You can see from the shaded areas showing recessions that a quick steepening of the yield curve happened right before both events in 2001 and 2008. Could this be the third time? You can see the curve inverted in early 2000 and again in 2006. When the curve steepening reached 50 bp the recession was at hand. We are currently at 26 bp.

According to Barron's, US valuations are at about 17.2 times forward earnings, which is about 20% above its average. Europe is running at just about its average while Japanese stocks are well below average. Maybe US stocks have run too far for too long and it is time to look for value elsewhere.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.