I heard an analogy that I really liked this week. It was from Tom Keen at Bloomberg TV (I might be biased as I was on with him earlier in the week). He was describing another analyst's view of the pendulum (sorry, I didn't catch the other analyst's name).
The description was that
- The pendulum has started to swing back. From extremes on growth to inflation, the pendulum is swinging back.
- At the moment, the pendulum is at a "reasonable" position. Think of this as the pendulum being at the bottom. If the pendulum just stayed there, all would be pretty good.
- But the pendulum will continue to swing and go past the point where things look normal or OK and get to a point where things look bad.
That analogy resonates with me as I am in the camp that inflation, jobs and growth are all slowing (and inventories and the need to discount are all growing), but the data so far are mixed. If the data stabilize around here, then things could be good, but I don't think things will stabilize.
Aside from our domestic challenges, the energy problems in Europe are building and low river levels in Germany may also disrupt trade. Over the weekend, China announced weak data and was forced to cut some key rates, which markets didn't respond to well.
My biggest concerns in the market are:
- Inventory build. We've discussed this in the past, but will harp on it again. Companies overestimated demand and over compensated for supply chain issues. Inventory is building and that is showing up in a number of reports, including shipping rates. We could have a day of reckoning for profit margins and a sharp decline in global manufacturing, which might be what China is telling us.
- Be careful what you wish for. Historically, declining commodity prices coincide with weaker stock prices. This huge push to lower commodity prices may backfire. That is especially true when the cure -- higher rates -- seems to have little to do with what caused much of the problem (supply chains and stimulus spending).
Bottom line
I expect the Fed pivot chatter to increase in the coming weeks, but while it will be good for bonds, it won't help equities as much.
One thing I'm torn about is whether major market participants are still too short or underweight the market, and whether funds that try to manage to a pre-set level of volatility will need to keep adding risk. Normally I would think yes, because the move has been rapid, but I'm far from convinced that is the case at the moment as markets and positioning seem to be moving at warp speed.
No need to be a hero in this illiquid summer trading environment. I still like owning some options, both to the upside, but more skewed to the downside.
Materials (SPDR S&P Metals and Mining ETF (XME) as an example) and emerging markets (iShares Latin America 40 ETG (ILF) as an example, which I currently own) have been working very well. I think I will take some profits here. Energy is making me nervous here (think SPDR S&P Oil & Gas Exploration & Production ETF (XOP) and VanEck Oil Services ETF (OIH) , both of which I starting scaling back on).
I'm looking into Japanese stocks as a compelling investment and am eyeing European bank stocks closely; if they can start to get a meaningful rebound that should be good for Europe as a whole, but there is a lot of upside potential in these beaten-down stocks.
