Animal Spirits
Has today's US inflation data changed the picture for markets into year end?
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The following section is for professional investors only. It reflects my own views in a strictly personal capacity and is shared with other likeminded investors for the exchange of views and informational purposes only. Please see the disclaimer at the bottom for more details and always note, I may be entirely wrong and/or may change my mind at any time. This is not investment advice, please do your own due diligence
The US released its monthly inflation data today. I perceive it as seminal, likely at very least until the New Year. A core CPI print of 0.2% month-to-month (or ~2.5% annualised) is low. More so, it is backward looking. We already know that the US economy is in the process of slowing, so one has all the reason to believe that further readings will also be low. What does this mean?
First, this means the market can bury the inflation topic until further notice. Second, it means that the Fed can takes its foot off the gas. Third, yes, growth is slowing, but it is not yet recessionary. Who knows if and when it will be, so imminently there is no reason to price in this very negative economic outcome (please see my last post on a possibly more resilient labor market)
These three dynamics in combination are bullish for asset prices. Thus, animal spirits are likely unleashed during a period where they are particularly prone to run wild, into the end of the year, as fund managers jump on anything that goes up to create performance before their 1st January pay day
In my posts last week I was somewhat on the fence as to what scenario would unfold going forward. I think the picture is a lot clearer now. Accordingly, right after the CPI print was published, I closed all my existing positions with the exception of the oil long, and I’ve bought the Russell 2000 (Small Caps) again in size, basically where I sold it after the QRA squeeze. I also added some Biotech exposure
Some notable charts to give context for today:
As we listen to the market, it tells us that the totality of US stocks has reclaimed its uptrend
Large speculators have shorted the Russell 2000 (Small Caps) in size last week (!). That and the fact that it has lagged the most this year make me think it is the fastest horse into Christmas
The 10-year yield has broken its fever and is not in an uptrend anymore. I do not see anything that can turn it aggressively before Christmas (though I could be wrong)
If you believe in chart analysis, then the Nasdaq-100 has generated a good signal for you, as it has broken out of a multi-month bull flag
Finally, if all assets are getting bought now as the fear of inflation recedes (rightly or wrongly, we will find out in 2024), those that are beaten down and high beta should rally the most. This applies to many Growth sectors such as Unprofitable Tech:
Hence, I also added some Biotech exposure, which has languished at multi-year lows despite tremendous advances and many companies trading at or below the cash value on their balance sheet
Michael Frazis whom I rate has made a could case here on why the lows might be in for the sector
Finally, I think there is some chance that after tomorrow’s Vix expiry and Opex later this week we get a small window of market weakness, before buying resumes again over Thanksgiving. I am leaning towards buying some short dated puts to hedge my long exposure for that possibility
It appears to me the odds are now that asset prices run until one side of the boat is fully crowded again, at which point it will then go the other way. I do not know when that is, perhaps early next year
Now, where could this view be wrong?
With economic momentum currently downwards, it is unlikely to be inflation or re-acceleration in the short run. The more worrying case from here is a recession, where growth slows so much that earnings get decimated more than equity valuations benefit from the tailwind from lower multiples. I do not think we will get evidence for this before Christmas, though as always I may be wrong
Further, Fed speakers could come out and aim to talk asset markets down by threatening further rate hikes. But why would they, unless we get more hot inflation data, which is unlikely for a while? Sure, they could try to talk the 2-year up and get cuts priced out again, but unless they guide towards further rate hikes, I am not sure the market would listen
Keep in mind, these are just my views as I see them and I could be wrong in my assessment, the timing, or both. Both data and/or price action could also evolve in a way in the coming days and weeks that my view is invalidated. But for now, I see good odds for animal spirits into year-end and am positioned that way
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A few thoughts. Equities more than front ran the adjustment in real rates we're seeing today. Valuations are still rich. And I'm no expert but when the prices of things most SP500 firms sell (goods) are declining while the cost of their main input (wages) is still increasing, I don't get optimistic about margins, growth or EPS.
I'll be alone in this, but I was more curious to the redbook report than CPI today. Now 3% yoy, weak and down from recent 5% readings. Cautious comments out of HD. End of day, more and more consumers are tapped out (even with health insurance supposedly down 30%+ YoY).
It's all about time horizons. If one thinks there are more ppl to join the EOY party, then by all means, Yolo some calls with the rest of the gamblers. Best wishes in getting out in time, once ppl question just how and why inflation is slowing (and where it's not).
Thank you so much for updating your thought processes and positioning! Today's note, like the previous ones, is very helpful. A quick question: do you see U.S. REITs as attractive at least for a short term trade? With the Fed on pause and a lower 10-year yield, do you think today's rally in REITs has legs?