The Observatory
Liquidity Tighter + Inflation Higher = Growth Contracting?
The Observatory is how we systematically track the evolution of financial markets and the US economy in real-time. Due to the strong demand for the product, we will start sharing the beta version of The Observatory (click to download) as we finalize its designs. This will offer a high-frequency resource to those using our systematic macro approach, allowing them to “Observe” the macroeconomy through our quantitative lenses. We will soon be launching the product officially, i.e., with explainer materials and a standardized format. And don’t worry, it’s all still free! Also, make sure to follow us on Twitter for timely updates:
Without further ado, let’s dive into what our systems are telling us:
Markets: Yesterday proved to be a (-) G day for markets, Equities and Commodities struggled, while Gold and Treasuries received support. This pricing proved challenging from a beta-rotation perspective; however, our alpha generation strategies benefited from gains in Lean Hogs and Treasuries. Currently, we think the predominant risk to the current (+) G (+) I regime is its success. As commodity prices continue to rally, this will constrain the discounting of economic growth. By our estimates, the dominant driver of the slowdown in Equities this year has been the spike in inflation pricing. This risk remains ongoing and could catalyze a (-) G regime shift. Our systems have guided us well through similar dynamics in past cycles; therefore, we continue to observe their evolution. To summarize our systems' current assessment: Our upgraded Market Regime Monitors show a dominance of (+) G (+) I. Despite our systematic forecast of a transition from (+) G (+) I into (-) G (-) I, asset markets have not confirmed this estimate year-to-date. Considering cross-asset correlations, the biggest threat to the current regime remains a sudden transition to (-) L. Consequently, our expected return and risk analysis tells us that the best opportunities are Long: Bonds, Cotton, Lean Hogs, Cattle, Sugar, and Short: Communications. However, our Risk Management Monitors indicate that we can ADD to LONG: Bonds, Cotton, Lean Hogs, & Sugar. We can REDUCE our LONG: Live Cattle and SHORT: Communications. While our Market Regime Signal continues to point to (+) G (+) I; however, from a portfolio construction perspective, our systems tell us it is optimal to be regime-neutral. Dispersion within asset classes is creating significantly more opportunities than asset class rotation. Resultantly, our Expected Return Strategy is LONG: Bonds & Lean Hogs.
Macro: Mirroring financial markets, the primary threat emerging to the real economy is the deceleration of growth faster than inflation. We will be observing this week's CPI data to evaluate this risk, though our systems imply a sequential slowdown in this print. To summarize our systems' current assessment: Our systems tell us that the deceleration in growth is underway, and likely to worsen in the near term, implying weaker Economic Momentum. Commodity strength is beginning to put pressure on real growth. Our Inflation Nowcasts show resilience in the levels of inflation. While inflation will decelerate, it could do so well after growth. Our Policy Impulse Index has shown further deterioration. Archetypically, this tells us the Treasury Curve is likely to flatten, Equity valuations are likely to compress, and Credit spreads will widen over the next 6 to 12 months. The degree of slowdown in the Policy Impulse is significant, and usually, such large moves tend to have substantial impacts.
The future is dynamic, and our systems adjust as new information is available. Our bias is to allocate for the existing regime while trying to peek around the corner to what the future may hold. Finally, we optimize these views to minimize portfolio risk, resulting in our trading signals. We show all this in the document below.
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