The Sleep Well Portfolio at a Glance
Is It a Bottom, Is It a Rally, No! Is Just a Bounce
SPY (Large Caps)
We saw a dip in equities across the board last week. This is how the market deal with dropping growth, slowing inflation and stalling relative inflation. Looking backward has typically been a challenging way to make money as an investor. Looking at current levels and what is to come in the medium term ( 2-4 months) is growth will continue to slow. GDP is important to equities because capital looks for a rate of change rather than an absolute number. “Are things getting better or are they getting worse?”, this is the question that stocks look at. Things are going from "great" to "not as great right now", and then projected to go to "marginally ok" in Q2. This is predominantly bearish for stocks and investors are still catching on that the buyers of last year have begun to hibernate.
One Month Risk Calculation – Risk Unchanged
TLT (Bonds)
Bonds are doing what bonds do in high inflation… go down. As Inflation is at an absolute high reading YOY we typically get rising interest rates. This leads investors to remain skittish of bonds and prefer growth-sensitive assets until yields reach an equilibrium. Any day now the risk in stocks will grow enough to offset the yield difference in stocks and money will flow out of equities and into bond. As long as bonds selling off and yields are rising there is capital flows into equities, what happens when that buying pressure flips and bonds begin to look more attractive?
One Month Risk Calculation – Risk Unchanged
GLD (Consumer Goods Inflation)
Gold is one alternative to bonds when CPI is elevated. More about this in the weekly topic of interest. Gold is moving in opposition so bonds and is stable or even rising in the short term. Gold can be volatile and can swing for week to week but its fundamental relationship to CPI and slowing growth holds true. One thing is for sure though… Gold prefers a falling dollar and falling interest rates. Right now we don’t have either. When bonds stall or even reverse gold is likely to bounce aggressively.
One Month Risk Calculation – Risk Decreasing
UUP (US Dollar Relative Deflation)
The dollar was projected to stabilize or even drop in Q1 of 2022. With interest rates dramatically rising and stocks falling we have seen this happen. Our models are pointing to a very strong dollar in Q2 of 2022 before weakening again in the later half of the year. What will cause this? I am sure the news will find a reason, the reason doesn’t matter as long as we are positioned for it. UUP will be strong contender while bonds remain in a freefall.
One Month Risk Calculation – Risk Unchanged
IWM (Small Caps)
Let the rally begin! We get huge buying days in bear markets and small caps crossed into bear market territory a few weeks ago. Besides being oversold in the short run, not much has changed fundamentally. Growth is still slowing, and small caps are at risk to rising interest rates. Risk off for now until we get a true change of wind direction.
One Month Risk Calculation – Risk Unchanged
EEM (Emerging Markets/ Relative Inflation)
As the Dollar stabilizes in Q1 we have seen EEM perform much better than US equities. As we have written about for months now, this was going to be the case in Q1. The tailwind that helps EEM now is about to reverse course and per our models, the time is now. Dollar strengthening and growth slowing… look out below for emerging markets. Rallies are good selling opportunities for a short seller, Until Q3 2022.
One Month Risk Calculation – Risk increasing.
Drivers for Current Portfolio Allocation
After a brief scare of war, the markets became oversold in the short term. This week it is likely we will get a reversal from the bottom and pullback in gold as well. Whatever the reason for the selling/buying it doesn’t shift the macro trend. Stocks have improved from their overbought levels seen in 2021, but have a long way to go before being a “good” price.
Dollar builds a strong base and is looking to launch from its levels into higher highs in Q2 2022. Sometimes the strength will happen before the quarter begins and sometimes it will happen during. The models are pushing more and more into the dollar as oil continues its meteoric rise. This is due to the relationship that bonds have right now will UUP. Bonds continue to be negatively correlated with UUP and this is bad news for bondholders.
TLT is a great asset to have when inflation is dropping or negative, right now we don’t have either. The closest thing we have is slowing inflation, but slowing is not the same as dropping. Once Inflation begins to drop as projected in Q2 Bonds will likely be a dominant force in the portfolio once again. Thankfully we have not been depending on this asset in recent weeks.
Weekly Topic of Interest
Why Gold?
Gold gets bad rap compared to the prefect child of investments (stocks). It is true that for many years gold will underperform vs stocks and will even underperform during inflationary years. So why is it touted for its safety?
Gold has been used as a currency since 550 BC. That is a relationship that continues to this very day. We can simply convert gold instantly to dollars or any other world currency in seconds. It is universally accepted as a valuable material.
Some crypto advocates are saying that cryptocurrencies are the new gold. While there is something to be said about cryptos' ability to be converted to currencies around the world it does lack one thing. What is the utility of crypto? For now, it is hard to convert a crypto code into anything other than a code. for now, that isn't worth anything in the real world except as a one-time transaction marker.
Gold on the other hand has some intrinsic value. Things that gold is used for other than currency…
Jewelry – Most of gold’s use is in jewelry. Showing possession of gold and jewelry is one way that we as humans show each other our status. Money is a status symbol and gold is money in metal form. Who knows, maybe one day we will have a necklace made of our bitcoins.
As a conductor of electricity – There is a gold standard in electrical conductivity. Gold holds the gold standard for its ability to conduct an electrical charge. Because of this gold is used in almost every electronic device made every year. Bullish technology could be bullish for gold.
Aerospace – due to gold’s ability to reflect radiation with minimal weight and with no toxicity like led, we use gold to coat many surfaces on spacecraft in order to protect astronauts from radiation.
Gold flake and window tint – Gold is the most malleable metal known to man. Some cool things we can do with gold is smashing it so thin it becomes translucent enough to use in windows and bendable screens. Now that is a bendable metal. http://www.sci-news.com/physics/worlds-thinnest-gold-07482.html
Regardless of all the cool uses gold has, why do we use it as an asset in the SWP/AWAKE? There are many alternative assets that can take the place fundamentally in the portfolio, but we use GLD due to liquidity, accessibility, and finally its long history of performance during inflationary times. Below I have a scatter plot of gold’s monthly performance vs CPI.
Source: Gold.org
I put a linear trend line on the graph so it is easier to see the positive relationship to CPI. Normally we would use bonds to offset our risk in stocks when growth is slowing but bonds have a crappy history of hedging a portfolio in high CPI times. I show this in the chart bellow…
Source: yahoo finance
Due to the propensity for rates to rise as inflation rises and fundamentally when rates rise they put pressure on lending, thus resulting in a slowing of the economy. Remember that yields rising is bad for bonds. It is likely that rising rates actually cause the very slowdown we are attempting to hedge against in our stock portfolio in high CPI.
Gold in orange, Total US stock market in blue. Source: Macrotrends
As a bonus, once the US dropped the Gold standard in 1971, gold has been able to flow freely with the market pressures. Looking at gold vs stocks, gold is actually an impressive asset on its own. The periods of underperformance are really only when Equities are blasting like last year.
Gold has its place and still plays a huge role in central banks' management of their currencies. This is the one asset that reigns supreme when currencies are failing and when stocks are struggling. For these reasons Gold is a large holding right now and is a welcomed asset when bonds fail to hedge a portfolio from falling equities.
Wrap Up
Gold and Dollar are kings. UUP makes its way back into the mix. UUP is a cash alternative. With this last week’s large move in gold, it was time to spread out some risk. UUP is the next best option until we see some strength in other assets.
US equities are chopping and causing all sorts of mixed signals to the macro unaware. For us that follow the trends in the macro-environment, we know that the real opportunity is in alternatives for now. Stocks will have their heyday again but for now, rallies are still missing legs and will likely result in disappointment.
May your assets grow and you Sleep Well,
Wayne Klump