Risk On Or Risk Off?
Darius joined our friend Anthony Crudele last week to discuss the current market regime, the 42 Macro Positioning Model, inflation, 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 Nailed The Correction In Risk Assets
Heading into this month, our 42 Macro Positioning Model, which tracks several short-term tactical indicators, including the AAII Bulls-Bears Spread, S&P 500 Implied Correlations, and AAII Cash Allocation, flagged an elevated risk of a tactical pullback.
These indicators suggested the market was overextended from a short-term perspective.
Whether a geopolitical catalyst occurred or not, we expected a pullback.
2. The “Immaculate Disinflation” Theme Is Dead
The latest March PPI and CPI figures supported our “Sticky Inflation” theme. Super Core CPI surged to 7.9% on a three-month annualized basis, three times the pre-COVID trend and well above the Fed’s 2% inflation target.
Across most sub-categories of CPI and PPI, as well as leading indicators like NFIB or the UMich surveys, there is an array of disconfirming evidence in the “Immaculate Disinflation” narrative. At this juncture, we believe that the “Immaculate Disinflation” theme is over.
3. “Sticky Inflation” Is Not Bearish In Isolation
Our “Jay And Janet Want A Soft Landing” theme hinges on two key factors. First, the Federal Reserve is more dovish than necessary. Second, Treasury net financing policy is contributing to favorable liquidity dynamics in this general election year.
Given these ongoing dynamics, we maintain that investors need not worry about inflation pressures in isolation. Unless the Fed or Treasury takes action to address sticky inflation, we believe asset markets can continue to perform well over a medium-term investment horizon.
That’s a wrap!
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Fed’s Policy On Inflation Is A ‘Step In The Wrong Direction’
Darius joined our friend Maria Bartiromo on Fox Business last week to discuss the Fed’s policy on inflation and what it means for asset markets.
If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio:
The Fed Is Kowtowing To Fiscal Dominance, And We Believe It Will Accept Higher Than 2% Inflation Over The Long Term
- The FOMC has stated that it would need greater confidence that inflation is moving sustainably towards 2% before easing policy. However, recent data hasn’t provided that needed confidence; instead, it suggests a prolonged timeline for achieving 2% inflation. If higher inflation persists, the Fed has stated they will maintain the current level of interest rates for as long as needed, rather than tightening further.
- When we refer to the monetary authority “kowtowing” to fiscal dominance, we are describing a situation where the Federal Reserve is being influenced by the government and fiscal policymakers. In 2023, the Federal Budget Deficit grew by $364 billion. The Fed is accepting the increased government spending will continue and inflation will remain elevated.
- Our analysis of prior economic cycles found that periods when the monetary authority kowtows to fiscal dominance are structurally bullish for risk assets like stocks and crypto and structurally bearish for assets like the bond market.
That’s a wrap!
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Is There Further Upside Risk In Asset Markets?
Darius joined David Hunter last week on our Pro to Pro Live to discuss the 42 Macro Positioning Model, the outlook for asset markets, our “Green Shoots Globally” theme, 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 There Is Likely Additional Risk To The Upside Over The Medium Term
Bears have found themselves reluctant to join the recent rally in equities.
Our 42 Macro Positioning Model monitors the aggregated non-commercial net length as a percentage of total open interest in the combined futures and options markets for US Equities. Currently, this indicator sits in the 33rd percentile of readings, notably lower than the median reading of the 62nd percentile seen at major bull market peaks.
Despite the significant market rally, we have yet to witness the structural upside capitulation characteristic of bull market peaks. This absence suggests there is likely potential for further upside over the medium term, although there may be a correction in the near term.
2. Cash On The Sidelines Stays On The Sidelines Until There Are Reasons For It To Exit
Currently, over $6 trillion is parked in money market funds.
Our analysis, spanning the last four cycles—2020, 2008, 2001, and 1991 —reveals a consistent pattern: cash on the sidelines tends to stay put in these funds until after a crash, recession, and rate cuts have each taken place.
We anticipate this cycle will follow suit, with the bulk of cash on the sidelines staying put until these pivotal events unfold.
3. “Green Shoots Globally” Continues To Support Risk Assets
In January, we authored our “Green Shoots Globally” theme that was supportive of asset markets.
The theme persists, as our models show that every major economy in the world has a Composite PMI trending higher—a bullish leading indicator suggesting what is likely to occur over the next three to six months from an economic standpoint.
Moreover, we track the number of industries reporting growth in the ISM Manufacturing survey. In December, that number bottomed. Our backtests have found that in the year following the bottom, the S&P generates a median return of 28%. While this is just one data cyclical framework to respect, it strongly suggests that the broadening of market breadth stemming from improving global fundamentals is likely to continue.
That’s a wrap!
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Managing Risk in a Risk-On Environment
Darius joined Caroline Woods on Schwab Network last week to discuss the current risk-on Market Regime and its implications for asset markets.
If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio:
The Market Remains In A Risk-On Regime, And We Believe It Has Room to Run
- At the beginning of the month, our Positioning Model flagged an elevated risk of a short-term correction. While some investors point to geopolitical factors as the cause of the correction, we believe the market was stretched thin in terms of positioning and needed a cooling-off period.
- We believe the market rally will continue because several fundamental themes, including our “Resilient US Economy,” “China Front Loading Stimulus,” “Green Shoots Globally,” and “Jay and Janet Want A Soft Landing,” may contribute to upside risk in asset markets. Until the drivers causing these themes dissipate, we expect asset markets to perform well.
- Although the Fed is discussing rate cuts this year, we maintain that the resilience of the US economy negates the need for cuts, as the economy continues to grow at an at-or-above-trend pace on a real basis and at a well-above-trend pace on a nominal basis. The hawkish repricing of policy rate expectations is bearish, but only to a point in this context. Said simply, the resilient US economy is unlikely to require rate cuts anytime soon.
That’s a wrap!
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What Does REFLATION Mean For Your Portfolio?
Darius joined Adam Taggart on Thoughtful Money this week to discuss the current REFLATION Market Regime, the resiliency of the US economy, the US consumer, 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. Investors Should Position In Line With The Current REFLATION Regime
Our 42 Macro Risk Management Process simplifies complex market dynamics into a straightforward three-step approach:
- Position for the Market Regime
- Prepare for regime change using quantitative signals with our Macro Weather Model
- Prepare for regime change using qualitative signals via our fundamental research
Currently, we are in a REFLATION Market Regime. In this environment, investors should consider the following key portfolio construction considerations:
- Risk Assets > Defensive Assets
- High Beta > Low Beta
- Cyclicals > Defensives
- Growth > Value
- Small & Mid Caps > Large Caps
- International > US
- EM > DM
- Spread Products > Treasurys
- Short Rates > Belly > Long Rates
- High Yield > Investment Grade
- Industrial Commodities > Energy Commodities > Agricultural Commodities
- FX > Gold > USD
To consistently stay on the right side of market risk, investors should position in accordance with the prevailing Market Regime.
2. The Resilient US Economy Does Not Require Rate Cuts, But The Fed Wants To Cut Rates Anyway
According to the March 2024 Fed Dot Plot, the Fed is guiding to three rate cuts in 2024, three in 2025, and three in 2026.
At the same time, the US Economy continues to prove resilient across various metrics, including income, consumption, and the labor market.
While we maintain the view that the resilience of the US economy does not justify rate cuts, the Fed’s inclination towards cutting rates has served as a positive driver for asset markets.
3. The US Consumer is Resilient Because of The West Village-Montauk Effect
The essence of the “West Village-Montauk Effect” can be summarized as follows: With a substantial stock of savings, there is less pressure to save a significant portion of your disposable income.
We are witnessing this effect in relation to the US consumer. Since the close of 2019, both households and corporations have experienced a boost in wealth:
- Household cash reserves have surged by 135%.
- Corporate cash reserves have increased by 51%.
- Household and corporate net worth have soared by approximately 34%, outpacing inflation.
This notable growth primarily occurred due to government spending during 2020 and 2021, which included COVID-related tax breaks, forgivable PPP loans, and extensions of jobless claims. A considerable portion of this expenditure entered private sector balance sheets. Simultaneously, as household and corporate net worth expanded, the monthly flow of US Personal Savings turned negative, demonstrating the eagerness of US consumers to spend a higher share of their disposable income due to the elevated stock of savings.
That’s a wrap!
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What Does “Sticky Inflation” Mean For Your Portfolio?
Darius joined Anthony Pompliano this week to discuss inflation, the “No landing” vs. “Soft landing” debate, the Fed, 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. The “No Landing” Scenario Is The Highest Probability Outcome Over The Next 12 Months.
The “Soft landing” vs. “Hard landing” vs. “No landing” debate continues. We define a “Soft landing” as a period of trend or below-trend GDP growth, facilitating a gradual return of inflation to trend over time. Conversely, a “Hard landing” signifies a period of GDP growth significantly below trend, which triggers a contraction in the labor market and ultimately leads to a recession. In contrast, a “No landing” scenario entails GDP growth at or above trend, enabling inflation to decelerate but not return to its 2% target.
Our analysis indicates that a “No landing” scenario is the most probable outcome over the next 12 months.
We employ two distinct models to forecast inflation. While the median forecast from these models suggests incremental disinflation in the upcoming quarters, by the fourth quarter, we anticipate bottoming at a level higher than the Fed’s 2% target. This scenario is likely to inflict pain on asset markets once policymakers react to this new reality.
2. Regarding Inflation, 3% Is Likely To Become The New 2%
In our recent deep dive into our secular inflation model, we found a noteworthy key takeaway: we anticipate that 3% will become the new inflation benchmark, replacing the previous benchmark of 2%.
We believe the Fed will acquiesce to 3% being the new 2%. This shift in perspective seems to be gaining traction, as evidenced by Chair Powell stressing inflation would return to its target “over time” during the March FOMC meeting.
While this transition will not unfold in a linear manner, we foresee that over the next few years, the Fed will embrace 3% inflation as the preferred target over 2% if getting inflation sustainably down to 2% will require a recession. This likely policy regime shift is structurally bullish for risk assets and structurally bearish for Treasury bonds.
3. A Variety Of Factors Have Contributed To The Recent Uptick In Inflation
We analyze several key metrics from the Cleveland Fed: the Median CPI, Trimmed Mean CPI, Median PCE Deflator, and Median Trimmed Mean PCE Deflator. Here is a breakdown of the latest figures:
- The Median CPI stands at 5% on a 3-month annualized basis, approximately double its pre-COVID trend.
- The Trimmed Mean CPI stands at 4.4% on a 3-month annualized basis, more than double its pre-COVID trend.
- The Median PCE Deflator sits at 4.1% on a 3-month annualized basis, approximately double its pre-COVID trend.
- The Trimmed Mean PCE Deflator, also on a 3-month annualized basis, stands at 3.7%, more than double its pre-COVID trend.
The surge in these inflation metrics is suggestive of a broad-based acceleration and a preview of what we are likely to witness towards the end of the year as inflation struggles to bottom at a level consistent with the Fed’s 2% target.
That’s a wrap!
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What Will Push Powell to Cut?
Darius joined Maggie Lake on Real Vision’s Daily Briefing this week to discuss the resiliency of the US economy, Immaculate Disinflation, Bitcoin, 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. The US Economy Remains Resilient
In September 2022, we authored our “Resilient US Economy” theme, and the prevailing data today continues to support this narrative.
Furthermore, our research indicates that the Fed is likely to implement easing monetary policies over the medium term. This confluence of factors—a robust economy operating at or above trend coupled with supportive monetary measures—has fostered a bullish environment for asset markets.
We believe asset markets are likely to continue performing well until either our “Resilient US Economy” theme dissipates or the “Immaculate Disinflation” theme concludes, forcing the Fed and Treasury to officially pivot to hawkish forward guidance and net financing policy.
2. Recent Labor Market Data Indicates Evidence of Sticky Inflation
The Feb JOLTS report confirmed that “Immaculate Slackening” persists, but investors should be worried by the apparent bottoming in turnover:
- The Private Sector Hires Rate ticked up from its cycle low to 4.1%
- The Private Sector Quits rate remained unchanged at 2.4%
An increase in employee turnover could disrupt the “Immaculate Disinflation” narrative. Because workers who change jobs tend to have faster wage growth, the bottoming in these indicators suggests that we may be running out of steam concerning the disinflation we have observed in wages.
Despite the February JOLTS report supporting sticky inflation, we continue to believe the “Immaculate Disinflation” theme is likely to persist for another quarter or two.
3. Bitcoin’s Current Correction May Worsen If The “Immaculate Disinflation” Narrative Dissipates
After rallying 75% from Feb 1st to March 10th, Bitcoin is currently in a consolidation period.
We anticipated this pullback. Over the past month, we have highlighted several extended tactical positioning indicators in our positioning model to our clients, such as the AAII Bulls Bears Spread and AAII survey, that suggested markets were likely overbought.
If the “Immaculate Disinflation” narrative loses steam, the current correction could deepen. If that occurs, investors would need to pull forward their timeline expectations of a transition from a risk-on REFLATION Market Regime to a risk-off INFLATION Market Regime.
That’s a wrap!
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How Will The Election Year Impact Asset Markets?
Darius joined Victor Jones this week to discuss the impact of the PBOC’s policies, inflation, the election year, 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. Policies Coming Out Of The PBOC Have Had A Meaningful Impact On Asset Markets This Year
Since December of last year, we have called for Beijing to implement front-loaded policy support as we entered 2024.
That is what we have witnessed, and that front-loaded policy support has had two significant impacts on global financial markets:
- It has contributed to the uptrend in global liquidity, as evidenced by our 42 Macro Global Liquidity Proxy, an estimate for global liquidity calculated by summing the Global Central Bank Balance Sheet, Global Broad Money Supply, and Global Foreign Exchange Reserves ex-Gold.
- It has supported a rebound in Chinese PMI, suggesting the narrative around the Chinese economy being a black hole is changing at the margins.
2. The “Immaculate Disinflation” Theme Is Likely to Persist For Another Quarter Or Two
Over the past two months, we have seen Headline PCE, Core PCE, and Sepercore PCE Deflator accelerate to well above trend rates on a three-month annualized basis.
However, investors do not need to be highly concerned about those increases at the current juncture because:
- Productivity growth remains above trend.
- Leading indicators such as the “Prices” and “Supply Chain” components of PMIs continue to indicate a likely deceleration in inflation.
- The “Shelter” component of inflation has not meaningfully decelerated despite ample housing price disinflation in the pipeline.
We believe the “Immaculate Disinflation” theme may persist for another quarter or two before inflation bottoms at an unpalatable level relative to the Fed’s mandate. At that point, we believe the narrative around inflation is likely to change, and asset markets are likely to be impacted.
3. Fiscal Policy Is Likely To Continue Supporting Asset Markets Heading Into The Election
One reason we have been bullish on risk assets is that we believed President Biden and Treasury Secretary Yellen would implement favorable fiscal and net financing policies this year, supporting our “Resilient US Economy” theme and US liquidity.
We believe the election remains a risk-on catalyst for now. However, asset markets are likely to face headwinds after the election.
Sometime in Q4, we anticipate the RRP balance to have declined to at or near zero and the TGA balance to have decreased by $250B from current levels. Those estimates represent dangerous starting points ahead of another round of debt ceiling negotiations on the horizon is poised to induce volatility in asset markets.
That’s a wrap!
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The Fed Pivots From Soft Landing To No Landing… And Got Incrementally Dovish
Darius joined Maggie Lake on Real Vision’s Daily Briefing this week to discuss the implications of the recent FOMC meeting, fiscal policy, AI, 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. The Federal Reserve Still Anticipates Three Rate Cuts in 2024
In this week’s meeting, the FOMC released its March Summary of Economic Projections.
In their projections, the FOMC:
- Increased the 2024 Real GDP forecast by 70 basis points to 2.1%, 2025 by 20 basis points to 2.0%, and 2026 by 10 basis points to 2.0%
- Lowered 2024 and 2026 Unemployment Rate projections to 4%
- Increased 2025 Headline PCE Inflation by 10 basis points to 2.2%
- Increased 2024 Core PCE Inflation by 20 basis points to 2.6%
- Retained three projected Fed Funds Rate cuts in 2024
- Increase 2025 and 2026 Fed Funds rate projections by one hike each to 3.9% and 3.1%, respectively
Since the summer of 2022, we have maintained our ‘Resilient US Economy’ theme and its potential to contribute to inflation settling at a level unpalatable to the Fed. Based on their revised projections, the Fed now agrees with our no-landing call.
2. The Fiscal Impulse Remains Decidedly Positive
The YoY growth rate of the Fiscal YTD US Treasury Federal Budget Net Receipts remains positive at 7%.
However, that lags the year-over-year growth rate of the Fiscal YTD US Treasury Federal Budget Net Outlays, which is currently 9%. This dynamic is further underscored by the 15% year-over-year increase in the Fiscal YTD US Treasury Federal Budget Balance, translating to an expansion in the budget deficit.
This incremental fiscal impulse we continue to see from the Biden Administration signifies an intentional effort to secure victory in the upcoming election.
3. The AI Theme May Be Overpriced for The Current Pace of Development And Deployment
While our overall outlook for the AI sector remains bullish, we anticipate gains to be increasingly experienced by other sectors, as we expect the market performance to continue broadening out as it has done over the past four to six weeks.
Furthermore, at 42 Macro, we closely monitor various metrics, including the combined S&P500 Tech & Communication Services Mean Price to Trailing Twelve Months (TTM) Earnings and Sales Ratios, along with the Combined Market Cap to S&P500 Market Cap ratio. Although the combined S&P500 Tech & Communication Services Mean Price to TTM Earnings ratio falls below the levels seen during the tech bubble in 2000, the Mean Price to TTM Sales and Market Cap as a % of the S&P 500 ratios exceed or match those observed during that period.
While these ratios may exceed these levels, we expect equity market performance to continue broadening out as investors acknowledge the high probability of the no-landing scenario.
That’s a wrap!
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A Glimpse Into Bitcoin
Darius joined Dylan LeClair last week to discuss the outlook for Bitcoin, how it fits into the 42 Macro KISS Portfolio Construction Process, ETF flows, 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. Understanding The Correlation Between Bitcoin’s Price And Volatility Is Crucial to Grasping The Dynamics of The Asset Class
Our research at 42 Macro indicates that although equities and fixed income are generally inversely correlated to volatility, Bitcoin tends to be positively correlated to its historical and implied volatility.
Moreover, our 42 Macro Volatility Adjusted Momentum Signal (VAMS) scores volatility relative to price to determine whether an asset is bullish, bearish, or neutral.
Following our VAMS signals has allowed our clients to be on the right side of market risk and remain long during Bitcoin’s large upswings this year. Investors who plan to add Bitcoin to their traditional multi-asset portfolio would be well advised to understand the correlation between Bitcoin’s price and volatility to ensure they are positioned for its large, volatile moves. At 42 Macro, we can help you do exactly that.
2. Investors Can Prudently Gain Exposure to Bitcoin Through The KISS Portfolio Construction Process
Our KISS Portfolio Construction Process, a 60/30/10 trend-following approach, helps clients gain exposure to Bitcoin from legacy strategies such as the traditional 60/40 portfolio.
The current allocation of our KISS Portfolio, determined using our Global Macro Risk Matrix and VAMS for dynamic position sizing, is 10% in Bitcoin, 60% in SPY, 15% in AGG, and 15% in USFR.
Although we have a positive outlook on Bitcoin’s future performance, mere belief is not sufficient to allow us to take a position. Our decision-making process relies on signals derived from the current market regime and signals from our VAMS. At 42 Macro, we help investors make money and protect gains in financial markets, and it is through strategies like KISS that we have empowered our clients to achieve these objectives.
3. The 2024 Bitcoin ETF Inflows Have Far Exceeded Expectations
The immediate success of the Bitcoin ETF out of the gate has been remarkable.
IBIT has been the most successful ETF launch in history, gaining an impressive $15 billion in AUM in the first two months.
However, Dylan informed our audience that the current demand for Bitcoin has primarily originated from Blackrock, Fidelity, and other institutional investors. Additionally, ETF issuers have indicated that the current buyers of BTC ETFs do not represent some of the largest pools of capital; those significant investors have yet to enter the market. As a result, we anticipate a fresh surge of capital inflows into the asset class in the coming quarters, which is poised to drive prices even higher.
That’s a wrap!
If you found this blog post helpful:
1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.
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3. Have a great day!