Inflation
Favor Health Care and Utilities for defensive positioning amid economic slowdown and volatility as the presidential election approaches. A Republican Sweep favors Real Estate and Materials, while the second most likely outcome, Democrat gridlock, favors Health Care, and Information Technology.
Oil markets will not be impacted by Venezuela in the near term, but by shocks from the Middle East. Maduro’s ability to stay in power in the short-term removes an avenue of oil supply relief. The same avenue is cut off if Trump is reelected. Geopolitical shocks in Venezuela could present tactical buying opportunities for Chile, Peru, and Colombia.
The cyclical economy is slowing today. Republicans are now more likely to win a full sweep, crack down on immigration and trade, and at least modestly stimulate the economy. Uncertainty and volatility will rise.
In light of last week’s employment report and this morning’s CPI, it’s time for the Federal Reserve to cut rates.
We consider the outlook for CPI inflation over the next 12 months. Our baseline forecast calls for core CPI to hit 2.40% during this timeframe and for headline CPI to fall between 1.74% and 2.49%.
We explain how to distinguish between ‘good’, ‘bad’ and ‘ugly’ unemployment, why bad unemployment is a much better gauge of the jobs market than headline unemployment, and what this means for the tactical positioning in bonds and stocks. Plus: base metals (XBM) have already sold off sharply, so take profits in the short position and open a tactical overweight in global materials (MXI).
In Section I, we examine some concerning signs of US economic weakness that emerged in June. We also discuss portfolio positioning in the face of falling interest rates and cross-check our recommended US equity overweight in the face of extremely optimistic expectations about AI’s impact on growth. We conclude that defensive positioning continues to be warranted. In Section II, we dig into those optimistic expectations for AI. We find that the US equity market is significantly overvalued unless the deployment of AI technology causes a 10-to-20 year productivity surge in line with what occurred during the IT revolution of the 1990s, with persistently high margins on the revenue generated from the improvement in growth. We doubt that AI will end up truly boosting economic activity by this magnitude.
The consensus soft-landing narrative is wrong. The US will fall into a recession in late 2024 or early 2025. We were tactically bullish on stocks most of last year, turned neutral earlier this year, and are going underweight today. We conservatively expect the S&P 500 to drop to 3750 during the coming recession.
The end of China’s exponential credit growth will impede structural rallies in Chinese stocks and commodities, but US superstar stocks’ bubble-like valuations will impede them too. Leaving European stocks as the likely structural outperformer. Plus: copper is correcting, NVDA is consolidating.
US assets and the US dollar should remain resilient relative to global peers over the next 12 months as policy uncertainty, election risk, and geopolitical risk reach a climax. After that, investors should reassess their regional allocation.