As noted in detail on May 14, it is always important to understand both the bullish and bearish case for stocks. We recently noted two potentially bullish developments: an unprecedented drop in investor fear, and what appears to be a successful retest of a long-term breakout for the broad NYSE Composite Index. While the headline number for Thursday's GDP report was impressive, the report contained something that may keep the Fed in a market-friendly mode.

A Dovish GDP Report?

A case can be made that this week's GDP report was skewed favorably by Uncle Sam. From Bloomberg:

"The GDP number's fine, not spectacular," Michael Block, chief equity strategist at Rhino Trading Partners LLC in New York, said by phone. "The inflation data isn't great and the quality of the GDP beat isn't great as a lot of it is from government and defense spending. It adds to dovishness."

Fear Of Deflation Impacts Fed

Low inflation can eventually slip into deflation territory. Once deflation takes hold, it can morph into a negative feedback loop know as a deflationary spiral. If you were surprised that bonds started strongly Thursday after what appeared to be a strong GDP report, there is a logical explanation. Bond buyers were focused on the inflation data. From The Wall Street Journal:

The lack of inflation in the U.S. and around the world remains a concern for economy watchers and a key factor keeping bond buyers around. Within Thursday's GDP report, the price index for personal consumption expenditures rose at a 1.2% annual rate in the third quarter, from 2.3% in the second quarter.

Investment Implications - The Weight Of The Evidence

As noted in last week's video, the improvement in the hard evidence has allowed us to scale into equity positions numerous times in the past two weeks. The "fear reset" in the VIX is still holding in a bullish manner for equities (see below). If the market can continue to gain traction based on earnings, GDP, and tame inflation data, we will most likely continue to increase equity exposure.

Concerns Remain

Europe's economy and low inflation could eventually impact the USA. We must also continue to keep an open mind about all outcomes as the Fed begins to normalize interest rates.