The Week's Data
Most data this week landed as good until today's retail sales number. Market reaction stayed muted, with no big swings in futures either way. Part of this is a dull August summer rally - low volume, few participants. The old rule holds: you don't short a summer rally.
CPI (consumer prices) and PPI (producer prices) both came in lower than expected. Retail sales today showed a small crack, but nothing strong enough to push the market in either direction.
Options Positioning
Option positioning points to long gamma dealer positioning. This keeps things muted because dealers sell the rallies and buy the dips. There is still a decent amount of put selling, especially in tech names. The VIX (volatility index) hit a one-day reading under 7 - a sign the market is watching paint dry. Things can shift fast, and markets can be fragile at all-time highs.
Hedging Has Dropped
I would like to report that investors are getting tactical and covering themselves in case the market rolls over. They are not. Hedging sits near the lowest 20th percentile right now. People seem fine with the rally and are not paying to protect their downside. This is a confident, quiet marketplace.
The Fed and Inflation
The economy is in a muddle-along state. PPI and CPI did not surprise to the upside, which is good, but they also did not show inflation falling to the 2% target. Non-farm payrolls and today's retail sales suggest a small crack in the consumer. Kevin Gordon described the payroll number as a hall of mirrors, making the true state of the consumer hard to read.
The likely result: the Fed stays on hold for now. Soft CPI and PPI give the Fed cover to skip a hike at the next meeting. The bar for hiking is getting lower, but a near-term hike is not expected.
Yields and Bond Strategy
The 10-year Treasury should keep trading in a range of 4.25% to 4.75%. It sits near the upper end now, with room for a bit more upside. The advice to investors is to favor slightly below-benchmark duration. One way to do this is through the Bloomberg US Aggregate Bond Index, which carries a benchmark duration of about 6 years - so aim just below that.
The exact choice depends on the investor's situation and risk tolerance. With the Fed on hold and possibly more upside in longer-term yields, long duration bets look unattractive. Still, do not fully avoid long duration, and do not hide out in cash. Spread out maturities while favoring a shorter benchmark duration.
The Earnings Tailwind
The market is moving past a strong earnings cycle that drove it to all-time highs, with over 45% year-over-year earnings growth. That tailwind will fade fast, maybe within the next couple of weeks. Attention then returns to the macro picture, which stays positive but is showing some cracks.
Charles Schwab (SCHW) supplied both the trading and derivative view and the fixed income research view.
