A picture is worth 1000 words

My wife told me last week that the Stay Vigilant was too long. She knows that I always tend to write too much and challenged me to keep it shorter this week. Given it is a long holiday weekend in the US, and many people won’t want to read much anyway, I accept that challenge. After all, a picture is worth 1000 words so I should need much more than a picture, right?

If I was going to show you just one picture, it would be the relative rotation graph. There is just so much information packed into the one picture. We can see what asset classes are doing well and which are doing poorly. We can see which are improving and which are weakening. I think the most important areas to watching are the weakening and improving. Those are the winners that investors are crowded into that are losing steam and the losers everyone is avoiding that are starting to do well.

In the weakening category we have all of the year-to-date winners: Momentum (factor), Japan, US, tech stocks and crypto. Bitcoin & Ethereum are in the far lower right and are off the page, not given their performance per se, but because of the higher volatility of the asset class. For the record, while the flows have been good into crypto, they will remain somewhat limited in relation to the total portfolio for institutional investors until they become less volatile. Institutions focus on risk-adjusted returns and not absolute returns. It is telling that these areas of the market are losing momentum particularly after the better-than-expected numbers from Nvidia, which also set the tone for the other Mag 5 levered to AI. The outside day reversal in the NDX index was an ominous sign on a day when the news was all good. Will we see rotation from the leaders to the laggards as we head into the summer months?

Flying right through the improving area and into the leading quadrant are China, commodities, silver, gold, FX carry and the UK. The latter might be surprising to some, but I wrote a piece for the CME Group that will come out next week that highlights how the UK Index, when compared to the US Index, has sector weightings that do much better in times of stagflation, while the US has better sector weightings for recovery and reflation. I also have written about how pre-Financial Crisis, China was a disinflationary influence on the global economy, but with a change in focus to the domestic market, may not be as much anymore. In fact, India is driving more commodity demand and India may actually be a stagflationary force on the global economy because it will drive the cost of commodities higher, but because of its educated technology workforce, may deflate not good that we buy but the service jobs that we want. More on this later.

Finally, we see in the lagging area of the market, all of the fixed income products like IEF (7-10 year Treasuries), TLT (20+ year Treasuries), AGG (global aggregate bond index), LQD (investment grade bonds). Headed this way are HYG (high yield bonds) and EMB (emerging market bonds). The one outlier in this group is Brazil, with EWZ being a clear laggard. Fixed income likely struggling because of higher for longer in the rates world that is potentially being driven by the improvement in commodity markets.

All in all, change in investor positioning is telling me people are focused more on stagflation, when growth slows with inflation staying high, rather than reflation where inflation falls while growth does well. That was the game, and it appears to be shifting, at least if we look at how assets have rotated in the last 8 weeks. It is our job as investors to assess what the market is pricing in and whether or not we agree with it. I just so happen to agree with this stagflationary view as I wrote about last week.

Enough though. I promised to not let this get too long. For those that celebrate, have a Happy Memorial Day. For all of you …

Stay Vigilant