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Lots of supposed panic about inflation and the Fed right now, so it's the perfect time to step back, zoom out and take a calmer view.
Secular Trends: Clean energy, Biotech, Amazon taking over the world
Business Cycle: Typically broken down into four stages: expansion, peak, contraction, and trough
Tactical: Shorter term themes (e.g. earnings beat/miss)
At Macrodesiac we tend to focus primarily on the narratives driving markets, and how they fit within these overall themes.
Sometimes (such as now), those narratives can cancel each other out:
Other times they pop clearly in (and out) of view, like pistons in an engine 👇
Let's focus on the business cycle first 👇
Let's check these off...
Recession: Economic activity contracts, profits decline, and credit is scarce for businesses and consumers. Monetary policy eases and inventories gradually fall despite low sales, setting the stage for recovery. DONE ✅
Early cycle: Generally, a sharp recovery from recession, as economic indicators such as gross domestic product and industrial production move from negative to positive and growth accelerates.
More credit and easy monetary policy aid rapid profit growth. Business inventories are low, and sales grow significantly. DONE? ✅
Mid cycle: Typically the longest phase with moderate growth. Economic activity gathers momentum, credit growth is strong, and profitability is healthy as monetary policy turns increasingly neutral.
Late cycle: Economic activity often reaches its peak, implying that growth remains positive but slowing. Rising inflation pressures and a tight labor market may crimp profits and lead to tighter monetary policy.
In past cycles, 1994, 2004 and 2011 were comparable years to where the economy is today.
We think 2021 will be similar for investors: flattish returns for the year with a 10-20% correction along the way.
The first quarter saw full-on cyclical rotation, with both reflation and reopening stocks leading.
But that is starting to morph now, with reflation plays still working, while reopening stocks take a breather on this execution risk.
To prepare for this execution risk, we downgraded small caps and early cycle stocks like consumer discretionary, while upgrading consumer staples and recommending a move up the quality curve across all sectors. At the same time, we've maintained our reflationary bias, with overweights in financials, materials and industrials.
Finally, remember that we're still only a year from the trough in the recession, and new bull markets tend to last for years.
The goal as an investor is to navigate the mid-cycle transition, avoid the stocks with the biggest draw downs, and be in position to capture the next leg. The first stage of that transition seems to be well along.
In short, taking down the most egregiously valued stocks as rates moved higher.
Small caps, early cycle stocks like semiconductors, and lower quality stocks are now underperforming, along with some reopening plays that got too extended.
It's likely that the S&P 500 will eventually feel it, too, before the transition is complete.
Time to update those sector watchlists and get selective or just keep buying those dips in indices until it doesn't work anymore?