Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
In my February 2024 Market Strategy article, I highlighted that the duration bid in anticipation of falling interest rates has gotten even more extreme. So far, the crowd has not been proven wrong. The winners kept winning and momentum kept going. NVDA 0.00%↑, the star of this bull market, ran another 20%, pulling up the S&P by another 3%.
But cracks are showing up. Red hot fiscal flows have revived the inflation menace. Investors are waking up to this threat which has started showing up in sentiment and positioning data. We might be on the verge of a paradigm shift.
Time to look again into positioning data, fiscal flow data and monetary policy indicators.
TLDR Summary
Triggered by CPI data coming in hotter than before, investors are now more attentive of inflation risks than before. Anecdotally, I have lately seen many people speculating that the Fed has lost control and the inflation problem remains unresolved. Some are even calling for higher rates. Others have identified deficit spending as the root cause of the misery. It’s important to understand that this issue is not on the fringe. Investors are not complacent about this problem. It’s front and center.
At the same time, investors are by and large still positioned for a soft landing. But they are clearly nervous about a reacceleration of inflation in a no landing scenario. As a result they moderately reduced their longs in tech in favor of cyclical bets in financials, energy and REITs. This may be a turning point in sentiment that precedes a larger asset rotation. The no landing narrative that I have been talking about for a while may be picking up steam and culminate into a near to mid-term outperformance of value stocks with cyclical exposure. As part of this risk-on trade, international exposure has also started climbing. It remains at extremely bombed out levels, which might present an opportunity.
It will probably make money for the remainder of this year to simply bet on that paradigm shift. But I have started looking into what will likely happen beyond the narrative horizon. No flight is forever. At some point, we will land. The question is how. In my opinion, we have to search for the answer in the fiscal cycle because it has been the key driver for this bull market.
The writing is already on the wall that the fiscal cycle will likely turn sour again soon for cyclical and seasonal reasons. I believe this will eventually ease the inflation problem and provide for a modest number of rate cuts, perhaps even more than are priced in right now. Some rate-sensitive and cyclically depressed industries will react very favorably to those. I am betting on pent up demand in those industries to avoid a hard landing anytime soon.
It should be noted however that we have an enormous tax drain coming up in April that may serve as a near-term BTFD opportunity. Afterwards, the goldilocks scenario will likely fuel and broaden the bull market.