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The Two Factors Driving U.S. Markets & How to Adjust Your Portfolio

In the U.S., it’s all about yields and inflation, both of which have overwhelming consensus views built based on the linear extrapolation of the most recent trends.

In the U.S., it’s all about yields and inflation, both of which have overwhelming consensus views built based on the linear extrapolation of the most recent trends, writes Landon Whaley. Join him at TradersExpo Chicago for two presentations July 24.

These consensus views are wrong, and we will be fading them in the weeks and months ahead.

The three primary gauges of inflation—Producer Price Index (PPI), Core, and Consumer Price Index (CPI)—are all currently accelerating in the U.S. The country’s PPI accelerated to a 3.4% year-over-year rate, the fastest pace of producer price inflation since 2011. Core inflation accelerated for the third consecutive month to an annual pace of +2.3%, the highest rate of core inflation in over a year. Finally, headline CPI hit a six-year high in June, accelerating to a +2.9% annual pace.

June marks the fifth consecutive monthly acceleration in consumer inflation. We could absolutely see a CPI print with a 3-handle in Q3 2018, something that hasn’t happened in seven years! That said, 3% inflation would be the signal of peak inflation, at least for this year.

Despite everyone’s belief that inflation is pulling a Superman and going up, up, and away, we believe inflation—along with growth—will begin to slow towards the end of 2018 and heading into 2019.

U.S. Yields Say What?

The other consensus view is that U.S. yields are also set to march even higher. The latest positioning data from the Treasuries futures markets backs this statement, as investors have moved even more short of U.S. Treasuries (long U.S. yields) all along the curve. As with inflation expectations, we are happy to again take the other side of this overwhelming consensus view that Treasuries are radioactive.

Both 10-year and 30-year yields peaked in mid-May and have been making a series of lower highs ever since. The market is already signaling the peak of the latest U.S. inflationary push. Remember, financial markets often front-run shifts in the underlying Fundamental Gravity. Pair this with a massively bullish shift in the Quantitative Gravity for long-dated Treasuries and it would appear that, once again, the crowd has overstayed its welcome.

For the next few months, we are likely to experience an economic environment characterized by accelerating inflation and a bearish trend in yields. This environment would allow the U.S. bond market to come to life while still letting energy-related commodities and equities to keep working for several more months. The caveat to this reality is that by Q4 2018 and Q1 2019, the reward-risk of these energy asset classes will be heavily skewed to the downside.

The Playbook

The current playbook for anything outside the U.S. is to be short or out entirely—there is simply no middle ground. Given the global Fundamental Gravity, there isn’t an equity market (or currency) on earth we’d be long right now outside the U.S. If you’re a long-only investor, you would ideally be completely U.S.-centric for the time being. However, for those of you mandated to have international exposure, we would limit it to developed nations and the lowest level of exposure your mandates allow.

In the Asset Allocation Model, we will continue to pound away on the short side of German, South Korean, Brazilian, and Chinese equities as those markets bounce to lower highs. The playbook in the U.S. is going to be influx over the next few months as we transition from the U.S. Growth a Go Go macro theme (currently active) to U.S. Shift Work (coming soon to a U.S. economy near you).

For now, reduce or outright eliminate your technology exposure on any further strength in that sector. You can still selectively attack consumer discretionary through the summer but keep your head on a swivel and maintain short leashes on those positions as we enter the back half of 2018.

As we make our way through the dog days of summer, begin to initiate positions in those asset classes and equity sectors that will outperform when the growth that is slowing globally finally reaches our shores.

You’ll want to initially focus on utilities, staples, and real estate investment trusts (REITs). At some point, we’ll also add Treasuries and gold-related assets to the list.

There is no Macro Theme this week, but we’ll be back next week rolling out our “Retail-iation” theme, which will become active in the second half of 2018 and allow us to get on the short side of U.S. retail companies that have enjoyed a monster 10-month rally after being left for dead in the early part of 2017.

However, we do have a “One Big Thing” driven by our perspective that bonds are about to make their presence known.

The One Big Thing

For the uninitiated, “One Big Thing” is a single trade idea from our universe of over 200 markets and several thousand companies worldwide. One Big Thing represents a trade idea, long or short, in which the reward-to-risk is skewed heavily in our favor.

Unlike our macro themes that play out over months, One Big Thing is focused on opportunities that are ripe now but may soon fade. These ideas are typically generated from a dislocation caused by catalysts in either our Quantitative or Behavioral Gravities.

This week’s One Big Thing is a long trade idea in the second most consensus bearish market on Earth, long-dated U.S. Treasuries, via the iShares 20+ Treasury Bond ETF TLT.

Fundamentally, the most recent tax plan passed by Congress drove Treasury yields higher to begin the year. However, that upward trajectory was interrupted, and as we mentioned in “The Playbook,” both 10-year and 30-year yields have been making a series of lower highs since May.

The economy is feeling the fiscal stimulus from that plan, but the entire benefit of the tax package is already baked into yields and, likewise, Treasuries themselves. In other words, investors have already priced in the economic boost anticipated from lower corporate and personal tax rates.

In addition to stimulus being priced in, the U.S. Fundamental Gravity will be shifting to a growth slowing regime as we approach the end of 2018. Once this shift is complete and the U.S. Shift Work macro theme takes hold, it will provide a very conducive investing environment for bonds of all types—especially long-dated Treasuries and TLT.

Since the end of May, all aspects of TLT’s Quantitative Gravity have turned bullish.

Social, which quantifies the trend of this market, is now registering party mode. This awakening shift is occurring alongside a shift in Momo, the force behind the trend, which has been building bullishly since May 29. Barometric, which measures the rate of force (buying/selling pressure), indicates that buyers have been in control since June 18, and buying pressure continues to build. Finally, Topo, which measures the level of drawdown risk, is registering the lowest level in four months.

Behaviorally, investors in the futures markets are massively short all along the curve, from the two-years out to the long bond. Outside of the Mexican peso, there is no other market in the world with a more bearish consensus perspective. The risk of a short squeeze is extremely high right now, which would add kerosene to our bullish fire.

Not to mention that specifically with TLT, investors have yanked more than $487MM just since May 1. We view this level of bearishness as decisively bullish when contrasted against the shifting Fundamental Gravity and the bullish Quantitative Gravity.

The Gravitational bottom line is that all three Gravities are bullishly aligned, which means it’s time to be long, strong, and down to get bullish with TLT.

The Trade Idea

We share detailed entry and exit guidelines with our research clients including specific price targets for risk and profit taking. In addition, we send out real-time alerts whenever we initiate or close a position in our Asset Allocation model.

If you’d like to receive the details for this long TLT trade and be notified when we are initiating the position, please email us at [email protected] We will also provide you with a free eight-week trial of our research offering, which consists of three weekly reports: Gravitational Edge, The 358, and The Weekender.

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This article was originally published by Founded in 1981, MoneyShow is a privately held financial media company headquartered in Sarasota, Florida. As a global network of investing and trading education, MoneyShow presents an extensive agenda of live and online events that attract over 75,000 investors, traders and financial advisors around the world.

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