Macro Assets At a Glance 5/24/24

SPY (Large Caps Equities)

The S&P 500 continues to reach new highs, primarily driven by credit easing and improving financial conditions, contrary to the widely perceived narrative of tightening. The Federal Reserve's actions, including significant liquidity injections and government spending in 2023, have bolstered stocks and prevented an aggressive deleveraging event. Current valuations, with PE ratios near all-time highs and a Peg ratio projecting 11.5% growth over the next five years, indicate an aggressively priced market. While prices may continue to rise due to speculative pressures, we remain highly sensitive to downside risks, similar to the situation in December 2021.

Risk Assessment: Medium

TLT (Bonds)

Bonds have retreated from recent highs, signaling easing inflation. This contrasts with our projections of increasing headline inflation over the next three quarters. This movement could indicate a flight to safety or simply reflect market noise within the broader downtrend of bonds and uptrend in interest rates. Currently, this appears to be a selling opportunity rather than a buying opportunity for bonds.

Risk Assessment: High

GLD (CPI Inflation/Real Interest Rates)

Gold's upward trajectory has continued, aligning with our longstanding investment thesis. Easing financial conditions, coupled with slowing economic growth and accelerating CPI, create a favorable macroeconomic environment for gold. While gold has recently pulled back, it remains a strategically bullish asset class in our portfolio, barring significant shifts in macroeconomic variables.

Risk Assessment: Low

UUP (US Dollar Relative Value)

The UUP has retreated from its highs, presenting a potential re-entry point if mean reversion tactics are employed. A strengthening US dollar, which typically occurs when the Federal Reserve tightens or maintains tighter rates compared to other economies, is conducive to the UUP. While this suggests further tightening, it conflicts with current easing financial conditions. We believe the Federal Reserve is laying the groundwork for another rate hike later this year in response to rising inflation and a possible recession.

Risk Assessment: Medium

IWM (Small Cap Equities)

Small-cap stocks, serving as our growth asset, have benefited from our bullish stance on equities. However, as with December 2021, we are prepared to quickly adjust our position based on macroeconomic factors and the potential strengthening of the US dollar, which could necessitate Federal Reserve rate hikes. The US Treasury's bond buybacks, which add liquidity to the market, are a potential mitigating factor.

Risk Assessment: Medium

EEM (Emerging Markets Equities/US Dollar Inverse)

Emerging markets present an attractive opportunity when the US dollar weakens. While not our current projection, a scenario could unfold where the Federal Reserve prioritizes printing over-tightening in response to elevated CPI. This would weaken the US dollar and create a strong case for increased allocation to emerging markets, although this is not our current position.

Risk Assessment: High

Summary

The overall market exhibits high valuations, reminiscent of late 2021, with the S&P 500's current growth expectations potentially exceeding its long-term average. However, we are still early in the tightening cycle, resembling the environment of June or July 2021. While the asset bubble persists, we continue to be guided by macroeconomic indicators and price confirmations. Until the bubble definitively bursts, we will follow prevailing market trends.

Federal Reserve members have recently expressed varying views on the economic outlook. For instance, Governor Michelle Bowman stated, "I expect that it will be necessary to further tighten monetary policy to bring inflation down toward our goal," while Governor Christopher Waller suggested, "We're seeing policy working...If inflation keeps moving down, we can stay where we are." This divergence in opinions highlights the uncertainty surrounding the future trajectory of monetary policy and its potential impact on asset prices.