Despite it all, investors buy without a worry

U.S. equities extended their smooth, upward drift to new record highs on Monday. The gains (chart below) came amid a collective shrug by investors after North Korea launched another ballistic missile over Japan overnight Thursday following the initial one on Aug. 29 and a nuclear warhead detonation. Both missile flights were of sufficient distance to strike Guam.

The latest good feelings started after Hurricane Irma wasn't the beast the Weather Channel made her out to be. The buying continued with an apparent effort at bipartisan policymaking by President Donald Trump. And it was capped by headline fatigue related to Pyongyang. Unless the North hits Guam, Wall Street seems to have written off this ongoing geopolitical flare-up.  

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Two major catalysts are now on the horizon. The first is the Federal Reserve policy announcement on Wednesday, during which the central bank is expected to launch its "quantitative tightening." That's something else investors seem unfazed by, as the Fed starts shrinking its ever-so-swollen $4.4 trillion balance sheet after years of bond purchase stimulus starting back in 2009.

But given the small size of the Fed's initial monthly reductions compared to the trillions in excess liquidity sloshing around the global financial markets, Wall Street is greeting "QT" with a collective yawn. Ditto for the rising odds of another rate hike in December. The futures market is assigning a greater-than-even chance to a quarter-point increase given the uptick in inflation data last week.

Despite a very tight labor market, wage gains remain tepid. Still, the experience of the 1960s suggests that so-called "cost push" inflation could quickly materialize in this environment, which could force the Fed to aggressively quicken its rate hike pace.

But very few people are talking about this amid an ongoing focus on anti-inflation factors like rising benefit costs (limiting wage gains), demographics (higher paid baby boomers replaced by cheaper millennials) and the drag from automation (robots replacing workers).

The next big catalyst heading into October will be hopes for a budget/debt ceiling/tax reform deal in Washington. The latest is that President Trump is looking to trade a softer stance on immigration for increased infrastructure spending and middle-class tax cuts -- a deal many Democrats would be willing to take. The wildcard is funding for a border wall with Mexico.

Maybe if Mr. Trump covers his wall in solar panels, as he recently suggested, he could make it an easier sell for the climate-minded on the left.

All this comes in the context of an economy that continues to chug along at "Goldilocks" speed: Economic growth is steady if middling, job gains continue apace and corporate earnings growth rebounded vigorously, thanks to the energy sector as crude oil holds near the $50-a-barrel level. Apple (AAPL) looks to be on the verge of another iPhone upgrade super-cycle boosted by the $1,000-and-up iPhone X, which will help everything from retail sales to overall S&P 500 earnings growth.

Any blemishes? Sure, if you look hard enough.

September is historically a tough month for stocks. In fact, it's the only one with a negative average return. And the folks at the Almanac Trader note that the S&P 500 has declined in 22 of the last 27 weeks after September options expiration (which was Friday) for an average loss of 1 percent.

Breadth (the ratio of stocks rising vs. falling) remains a problem as well. Jason Goepfert at SentimenTrader noted that the Dow Jones Industrials index snagged four record closes in a row last week, but with fewer than half of its components rising. Moreover, "smart money" traders are holding a $9 billion short position in the Dow mini futures, which is among the most extreme bearish bets in history.

Yet for now, with sentiment and valuations at extremes, stocks look untouchable. 

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.