Sticky

Friday, April 12th, 2024

US core CPI will be above 3% in 2024 and for much of 2025

Our standard probability approach suggests that the probability of US core CPI falling below 3% in 2024 – let alone down to 2% – is effectively zero. We think the central point of the forecast range should be between 3.5-4.0%. There parts of the US economy which are exhibiting disinflationary trends, but the cost of shelter, especially Owners’ Equivalent Rent, is likely to remain elevated for several quarters. The Fed needs a major policy rethink about how it manages market expectations on the outlook for core CPI, and on how it addresses the rising cost of home ownership in its overall policy mix.

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Respect the Seasons

Tuesday, April 2nd, 2024

Bonds expected to correct before equities

US Equities have been overbought for the last nine weeks, but there have been three longer streaks than this since 2000. Late March is one of two seasonal peaks for expected returns on the S&P 500. Q2 normally produces sub-par but positive returns and the greatest risk of negative returns only comes in Q3. Seasonality also suggests that Treasuries can be weak in Q2, which would fit very nicely with a narrative of only two rate cuts from the Fed in 2024. So even if equities are due some profit-taking, we are reluctant to switch into Treasuries, until they have corrected. We do expect some change in sector leadership, but not a wholesale switch into the laggards. Relative strength and sector persistence data both suggest that leadership will rotate around the top five groups: Financials, Industrials, Technology, Communications and Consumer Discretionary.

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Should We Worry about Health

Friday, December 1st, 2023

The sector is in need of therapy

Healthcare has been underperforming all year. We are underweight in the US and Japan and may soon be forced to downgrade in Europe as well. There are a number of possible explanations, ranging from the industry specific to macro-economic, and from portfolio construction to US politics. None of them, on their own, is particularly convincing, but in combination they form a powerful cocktail. Our models are telling us there is a problem, but we are not sure what it is.

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Stall Speed

Monday, October 23rd, 2023

US equities may be on the verge of a short-term correction

One of our key indicators for US equities is flashing amber. The recommended weighting when compared with a portfolio of 10-year Treasuries and cash has fallen to a level where it historically continues down to zero more often than not. This could be accomplished by a correction in equities or a rally in bonds – very probably a mixture of both. However, we are more optimistic about the medium-term future. We don’t think this correction would indicate an upcoming US recession. It’s very difficult to have one, when the Federal budget deficit is over 6%. In our view, the correction in equities is a necessary pre-condition for putting a short-term floor under the Treasury market.

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All Trussed Up & Nowhere to Go

Friday, October 6th, 2023

US fiscal profligacy is the new ingredient in this bond crisis

This is a companion piece to last week’s note about the US 10-year Treasury – Why Yields Could Go to 6%. We think we are in a new trading range of 4.3-5.3% and that the biggest single reason for the change is the administration’s plan for 6% budget deficits until the end of the decade. We think there is a significant risk that it will be self-defeating, and that it is too close for comfort to the Liz Truss plan in the UK. We also think that the Fed is happy for bond markets to preach the virtues of fiscal restraint to the administration and is unlikely to ease rates in the absence of a financial accident. The latter is, of course, the most likely outcome of such a dramatic rise in yields.

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Timing the Market Successfully

Friday, September 1st, 2023

Modelling the behaviour of risk-seeking investors

For some time, we have been interested in the behaviour of risk-seeking investors, which we model using a variant of our standard approach, called a pro-risk momentum model. We find that it can be used to time switches between cash and US equities, so that our model outperforms US equities on a standalone basis over the last 50 years. This is a result which most academic research regards as unachievable. In absolute terms, the quantum of outperformance is not material, but the risk-adjusted returns are clearly superior and the drawdowns are significantly smaller and shorter. We find that the same approach also works when combining US 10-year Treasuries with cash and a broad commodity index with cash.

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False Sense of Security

Monday, July 10th, 2023

7-10 year Treasuries offer no hedge against equity declines

We are mystified by the ongoing strength of the long end of the US yield curve. We fully acknowledge our bias towards a higher-for-longer view of inflation. Even so, we don’t understand why investors are willing to put up with lower yields and higher volatility than they could get by investing in shorter-dated Treasuries. Over the last 18 months, 7-10 year US Treasuries have delivered absolutely no protection against a decline in US equities. In fact, they have a tendency to decline at the same time and this downside beta has been getting worse. The same relationship affects all Treasury maturities from 1-3, all the way out to 10-20, but the 7-10 year index has the worst beta.

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Worlds Apart

Monday, June 26th, 2023

US Megacaps are behaving like a separate asset class

For some time, we have been discussing with clients the possibility of dividing up the equity universe in a different way, to give us more flexibility with our regional equity allocation. To do this, we would have to split the US into two. There are many ways in which this could be done, but it is really hard (actually impossible) to come up with financial metrics or thematic approaches which would give us a consistently applicable framework, without lots of anomalies. So, we opted for a really simple definition: the top 10 stocks, from time to time, vs the rest. These typically account for just over 40% of the market capitalisation of the S&P500. We find clear evidence that this group behaves differently from the rest of the US, often having an overweight position, when the rest of the US is underweight. As far as the current situation is concerned, we suggest that the right way to fund an increased exposure to Nasdaq, FAANG or Megacaps, is not to sell European stocks, but the rest of US equities.

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Nothing Doing

Friday, May 19th, 2023

Only high-conviction idea should be actioned

These are confusing times in financial markets, with little direction in any of the main asset classes. This week, we focus only on the high-conviction ideas generated by our models covering asset allocation, commodities, equity sectors, individual countries, credit and different maturities in government bonds. In general, there are more negative, than positive, high-conviction ideas. These include topping signals in many Eurozone countries such as France, Italy, Germany and Spain and for the Eurozone as a whole. We have high-conviction negative signals in Financials across all regions, apart from China, and other pre-recession signals in sectors like US Industrials and UK Materials. The positive signal in asset allocation is for US equities, but the level of conviction is lower than the negative call on the Eurozone, and is heavily dependent on the positive view of US Communications going forward. We like Europe, ex Eurozone, particularly Switzerland and Denmark, and detect signs that India may be bottoming, though the rest of EM Equities are highly unattractive.

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If It Walks Like a Bull

Friday, February 3rd, 2023

It can still fall over in the near future

Our mainstream sector and asset allocation models are producing signals which we would normally expect to see that the start of a new bull market, and not all what we expected in Q4. Much of this is because we have had two bullish surprises (end of zero-Covid in China and the postponement of the US recession), but we should also acknowledge that equities in the UK, and probably the Eurozone, are going to reach new all-time highs in the near future. What is this, if not a bull market? Alas, the same is not true of the US. There is already a recession in US earnings estimates, driven by tight labour markets, margin compression and over expansion in the Tech sector. Estimate drawdowns can last for over two years and the current one has only been going for 31 weeks. New bull market, or bear market rally, call it what you will, it isn’t going to last much longer.

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