Investing in the swamp

Stagflation means higher inflation and a slowing economy. Fun fact: the word “stagnate” is derived from the Latin word for “swamp”. As the Fed attempts to combat that inflation via monetary policy, there are factors that may influence the potential for stagflation. In my last blog, I summarized the typical pattern leading into economic contraction, and noted signs of growing economic stress, along with conditions that will challenge NA governments in combating inflation. Swamp, indeed.

I was fortunate to interview Maxime Bernier on the subject of economics a while back. We discussed the potential for Canada & the USA to enter a period of stagflation. Interestingly, Mr. Bernier’s comments regarding certain nations who followed a different path to that of North American governments seem to be coming true.  For example, Switzerland’s post-Covid debt/deficit control has paid off with an inflation rate of 3.3% and an unemployment rate of just over 2%. So….It can be done! It just takes a government with a basic understanding of economics. Meanwhile, Justinflation Trudeau blames everything but his governments spendy ways for our current inflation – and a probable recession.

Anyhow…Here are some new data points for your investment planning consideration:

JPM suggesting central banks move Inflation target to 3%

Latest inflation shows inflation is NOT falling in items that matter: Personal consumption is falling – it came in at +1.4% vs the expected +2.0%  – this is known as PCE (personal consumer expenditures). QoQ inflation for personal consumption items (aka not big ticket items like cars etc) came in at +4.3% vs the expected +3.9%. Go back to my last blog – note the path towards recession (rising rates, consumers buy less, producer output declines, job cuts, recession).

Please read this twice: Generically, when Core PCE is revised higher and consumption is revised lower, that is consistent with stagflation i.e., a stagnate economy suffering from inflation. 

Meanwhile, back at the GDP ranch: US gross domestic product growth came in lower at a 2.7% annual rate in the second estimate for Q4 compared with expectations for no change at 2.9% (largely due to a weak December).

Rising core inflation, falling GDP. Stagflation, baby! My last blog discussed sectors that hold their own during such periods.

Wonder why we got a January rally?

How do we know where the market is moving? Simple: Its all about the market’s perception of potential Fed policy moves. Next question: How do we spot investor perception of Fed policy moves?

If you read my book Smart Money/ Dumb Money,  you may recall my description of a little-used tool for spotting investment crowd behavior patterns. Searching popular terms such as “Fed pivot” using Google trends will offer valuable clues to spot dumb money patterns. For example, if the market is being driven by hopes and wishes for a pivot.

Here is the Google trends chart for the term “Fed pivot”. Note that the term became a highly searched topic as hopes grew for monetary easing in January. This chart clearly shows that the rally in January was based on a whim. It didn’t matter that the Fed has stated all along that they will remain “tight” until further evidence of inflationary control is seen.

Note the decline in searches under the topic of Fed pivot. Seems that “pivot-excitement” is falling off. This is another data point to consider when judging the viability of a continued rally….

Signs of economic distress

Large real estate investors in the US are showing signs of distress  (see my interview with Bruce Joseph for the Canadian perspective):

Pimco-Owned Office Landlord Defaults on $1.7 Billion Mortgage — office properties (notes on seven buildings) owned by Pimco’s Columbia Property Trust range from New York to San Francisco. Almost $175 billion* of real estate credit is already distressed — about four times more than the next biggest industry – Bloomberg

Consumers are distressed, too:

From MarketDesk Research

“Leading indicators deteriorated rapidly in 2H 2022, and there is no clear catalyst to sustain January’s strong activity. Our view remains that the economy and macro setup will continue to deteriorate as 2023 progresses, with recent strength simply delaying the expected slowdown and forcing the Fed to risk being too hawkish.” – MarketDesk Research

Here are some charts from MarketDesk for you to ponder on.

• Top left chart suggests purchasing managers index is signaling recession in USA, whereas Europe (top right) is on the mend. Time for a new look at Europe? I’ll be blogging on that topic soon.
• Middle left chart shows that banks are tightening their lending standards. More to come, which implies more pain to come.
• Bottom two charts show that home sales and mortgage applications are tanking.

As noted above – (PCE inflation), core inflation items like groceries and rent remain elevated. This (to me) suggests that even as big ticket items like housing/auto inflation subsides, the more sticky PCE inflation remains.

Conclusion

I can’t advise you on how to structure your portfolio. You need to deal with ValueTrend in order for me to do that. But, I can outline how we have been generally positioning our equity platforms.

If you have taken my online course (and I HIGHLY recommend you do so if you have not already), then you know that ValueTrend follows a very structured process to identify bear market, consolidation, and bull market patterns. We move into, and out of equities according to this macro model. We also deploy a sector rotation model. In all cases, these moves are further structured via a process of legging into, or out of positions. Nothing is done in a knee-jerk way. All of this is covered in the Online Course.

Right now, we are about 23% cash in our equity platform. Indications are that the SPX is breaking down from its 4100 key technical level. The TSX is breaking its 20,500 key level. If these are not recovered into early next week, we will add to cash.

Meanwhile, we have been rotating what equity we do hold into specific inflation sensitive positions. Specifically, energy and materials – having been light on these sectors for the past 12 months.

I hope this helps. If it does, forward the blog to a friend and encourage them to follow & subscribe. Back next week with a special guest interview that I know you will benefit from.