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As economy hits lull, investors bet on more Fed stimulus

Despite some weaker-than-expected economic data over the last 48 hours, including poor retail sales, weak industrial production and an ongoing buildup of inventories, stocks continue to push higher.

As of early trade on Friday, the Dow Jones industrial average has moved over its 50-day moving average for the first time since October, recouping more than half of its December-February wipeout.

This is directly at odds with the furious pace at which economists are marking down their economic growth expectations. According to Macroeconomic Advisors, the soft data has led them to reduce their first-quarter 2014 GDP tracking estimate to just 1.8 percent. As recently as mid-January, the consensus estimate stood at nearly three percent.

What we're seeing is the return of the bad-news-is-good-news meme as weaker economic data bolstered the argument that the Federal Reserve could slow the the pace at which it is scaling back its bond purchase program. That policy, known as quantitative easing, is aimed at stimulating economic activity by keeping a lid on longer term interest rates.

The forecasts for slower growth are lifting pretty much all asset classes on dreams of more cheap money. But it's also hammering the U.S. dollar, which is dropping out of a multi-month trading range -- setting up a test of the 2011 lows and surge of inflation.

This comes despite comments earlier this week from new Federal Reserve Chairman Janet Yellen that it would take a "notable change" in the economic outlook for the central bank to pause the tapering.

Yesterday, the "bad news" was a big miss on retail sales, which fell -0.4 percent in January over December, versus the -0.1 percent drop that was expected. Auto sales were largely responsible, dropping 2.1 percent following a 1.8 percent drop in December. Inventories are starting to accumulate on dealer lots, which should force factories to idle, which in turn should be reflected in factory activity measures in February onwards. So watch for that going forward.

On a related note, overall inventories grew 0.5 percent for the month, versus a 0.4 percent build that was expected. That pushed the inventories-to-sales ratio to its highest level during the recovery (which is bad). Again, this should result in a drop in factory activity unless demand bounces back soon.

That dynamic was already in play in December, as reflected in Friday's soft industrial production report, which showed activity down -0.3 percent compared to November.

Overall, we haven't seen a bout of economic softness like this since mid-2012. And that's why investors believe the Fed will tap the brakes on the taper.

My hunch is that the taper continues, but that the new "forward guidance" tool of promising to keep short-term rates lower for longer (which is why stocks surged when Yellen spoke on Tuesday) will be deployed.

Either way, the Fed's likely response to the soft data means the cheap money pump will continue that much longer -- and bring forward the day that inflation bubbles up (which is a stated Fed goal anyway).

That should be expedited by the breakdown underway in the dollar. If that happens, inflation will kick up faster than many believe as import prices and crude oil prices will push higher due to the currency effect. 

In response, precious metals and the related mining stocks -- one of the few areas of the market still offering value -- are shooting higher like they've been fired from a cannon. Picks include Great Panther Silver (GPL), which is up nearly 20 percent since I added it to the Edge Letter Sample Portfolio on Monday, as well as the Global X Silver Miners ETF (SIL), which is up more than 9 percent. 

Disclosure: Anthony has recommended GPL and SIL to his clients.

Anthony Mirhaydari is founder of the Edge, an investment advisory newsletter, as well as Mirhaydari Capital Management, a registered investment advisory firm. 

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