Macro Assets At a Glance 5/15/24
SPY (Large Caps Equities)
The S&P 500 has reached elevated levels due to a recent inflation report that fell below expectations. Although inflation cooled month-over-month, our models still anticipate increasing inflation through the end of the year. This should create a headwind for the S&P 500 and U.S. stocks in general.
Risk Assessment: High
TLT (Bonds)
With the newfound weakness in inflation data, bonds appear to be an attractive asset class again, in theory. However, our projections indicate that inflation will continue to accelerate through year-end. This is likely the lowest point the 20-year yield will reach, with yields expected to rise from here until we see significant slowdowns in inflation.
Risk Assessment: Medium
GLD (CPI Inflation/Real Interest Rates)
With inflation still above the long-term average and interest rates easing slightly, gold is enjoying an upward push. As always during historical periods of higher inflation and subdued growth projections, gold is one of the better asset classes, which is why we've held it in our portfolio and why it has performed well this year.
Risk Assessment: Low
UUP (US Dollar Relative Value)
Lower inflation readings and excitement over potentially lower interest rates have created an environment for the US dollar to weaken slightly. If this continues, we may see emerging markets as one of our stronger asset classes. However, this contradicts our current projections that the Federal Reserve will need to remain tighter for longer as inflation accelerates through year-end, which would likely lead to a strengthening dollar, rising gold, and rising interest rates.
Risk Assessment: Medium
IWM (Small Cap Equities)
Small-cap stocks have always represented the growth aspect of our portfolio, but growth projections remain subdued for the next few quarters. That said, small-cap stocks are significantly more volatile than large-cap stocks, creating opportunities for larger swings both up and down for traders. As for our portfolio, this recent push higher simply allows us to rebalance. With our projections of rising rates for the remainder of the year, we don't expect much upside out of small-cap stocks.
Risk Assessment: High
EEM (Emerging Markets Equities/US Dollar Inverse)
With a lot of focus on China and its heavy weighting in emerging market equities, the news of China's further investment in infrastructure, the "Made in China 2025" initiative, and a strong GDP ratio make emerging markets look more favorable. However, the relationship to the US dollar is crucial for emerging markets, and excessive tightening by the United States due to continued inflationary pressure could lead to a strengthening dollar, creating a headwind for emerging markets. We're keeping an eye on this as it develops. Currently, our portfolio is blending emerging markets and the US dollar as a hedge, with allocations likely fluctuating from week to week.
Risk Assessment: Medium
Summary
Inflation increased 3.4% year-over-year with a slight month-over-month slowdown. However, it's important to remember that this is against a high base effect from April 2023, when inflation was 4.9% year-over-year. While recent readings may sound positive, the fact that they're still growing from last year's high levels suggests inflation is not finished. As base effects continue to drop, inflation readings will likely show acceleration on a year-over-year basis.
We're focusing on the month-over-month data, which still shows a 0.3% increase. This would lead to a 3.7% year-over-year increase, still far above the Fed's 2% target. This leads us to believe the Fed will need to raise rates or take more aggressive action to curb inflation for good.
The market expects two interest rate cuts this year, which we believe is optimistic unless we see a strong economic downturn. In that event, growth assets will suffer, meaning stocks will face a headwind either way. Rising interest rates or an economic slowdown will both be headwinds for stocks.
Currently, our portfolios have exposure to stocks but are on a knife's edge, similar to December 2021. We're increasing exposure to gold and the dollar, but not yet to bonds. We'll need to see a sustained drop in inflation before moving into bonds again. If the Fed does cut rates with inflation at 3% month-over-month and 3.7% year-over-year, gold could soar as the US would be spurring asset inflation during a time of CPI inflation. We saw this in the 1970s when gold tripled.
Overall, we see stocks as extremely overvalued in the long term and entering a bubble in the short term. The US dollar is likely to remain stable, emerging markets are becoming more attractive, and gold remains one of the better asset classes in the medium term.
