Darius hosted our friend Kris Sidial on this month’s Pro to Pro Live to discuss the 42 Macro Positioning Model, inflation, the Fourth Turning, and more.
If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio:
1. Our Positioning Model Suggests Vulnerability In Equities
Our 42 Macro Positioning Model monitors 14 indices relative to their historical time series. By identifying the thresholds of each indicator that correspond to major bull market peaks and troughs, we can determine whether we are approaching cyclical tops or bottoms in asset markets.
Currently, six of the seven indicators related to equities are flashing red. Specifically, the AAII stock allocation, AAII bond allocation, AAII cash allocation survey, S&P 500 realized volatility, S&P 500 implied volatility correlations, and the S&P 500’s valuation have all breached historical thresholds observed at bull market peaks.
The positioning cycle is not ever the cause of breakdowns and breakouts in stock market momentum, but it does act as an accelerant once a catalyst(s) has triggered. That means investors should be on higher alert than normal for signs of rapidly deteriorating fundamentals. A better process would be to trust proven risk management signals that will help you book gains closer to the top than waiting for or even attempting to [oft-erroneously] predict those catalysts.
2. Is 3% Inflation The New 2%?
At 42 Macro, we have conducted an in-depth analysis of the economic dynamics surrounding the Fourth Turning.
Our findings suggest that over the next decade, investors should anticipate significant upside surprises in the growth of public debt relative to current projections and a marked increase in inflation compared to the pre-Fourth Turning baseline.
This conclusion aligns with a report we published in January 2022 featuring our secular inflation model. Our analysis revealed that the Core PCE trend from 2010-2019 was 1.6%. However, our models project that the trend for 2020-2029 is likely to be between 2.6% and 3.0%.
3. A Higher Inflation Trend Will Have Important Implications For Investors’ Portfolios
The inflation outlook during the Fourth Turning has significant implications for the stock-bond correlation and investors’ portfolios.
In periods of 1-2% Headline CPI, as experienced over the past decade, the stock-bond correlation tends to be negative. Conversely, in periods of 2-3% Headline CPI, the correlation becomes positive, and increasingly positive beyond those levels.
If our Fourth Turning thesis holds true, a traditional 60/40 portfolio is likely to underperform more thoughtful asset allocation strategies over the next decade. Investors will need to consider alternative instruments, such as volatility products, to hedge their portfolios effectively. Investors should consider the 42 Macro KISS Portfolio Construction Process, which is already being relied upon to deliver superior investment performance for thousands of investors around the world.
That’s a wrap!
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