It was a decent week. Markets continue to work their way higher, and more importantly, breadth got better, with more stocks participating both here and, increasingly, around the world. The bigger story is inflation: CPI, PPI, and import and export prices all came in hot, which tells us a second wave may be building. That is exactly why the groups that can set price, financials, industrials, materials, energy, and semiconductors, are leading the market, while the bond-like defensives keep flagging.
The correction in precious metals also looks to have run its course, and we think we have seen the shakeout. We are carrying about 9% cash because summer can get bumpy heading into a midterm election, but we are not hiding in defensives. Next up, we will be watching closely to see how the market handles Kevin Warsh’s first speech as Fed chair.
Key Takeaways:
- Breadth is broadening, and that’s what we want to see. More stocks are participating, not fewer. NYSE breadth improved, the equal-weight S&P and the Russell 2000 went to new highs, and a meaningful chunk of stocks flipped back to positive momentum and above their long-term trend. When breadth expands, we give the market the benefit of the doubt.
- Inflation looks like it’s putting in a second wave. CPI, PPI, and import and export prices all came in hot, which fits the pattern we’ve tracked in past cycles: a moderation, then another leg higher. Thirty-year Treasury yields are pushing on the top of their range, and we care if they trade up through 5% for any length of time.
- We stay with the groups that can set price. Financials, industrials, materials, energy, and semiconductors all have the ability to put up price tomorrow if there’s inflation today, and they’re the ones leading. Royal Bank and the Canadian banks, Santander in Europe, Caterpillar and Bombardier, the rails, copper and the metals, are all doing exactly what they should in an inflation-adjusted world.
- The leadership is increasingly outside the US. International equities have the strongest relative strength across the asset classes. Valuations are cheaper, dividend yields and growth rates are often higher, the sector mix hedges inflation, and a softer US dollar helps. That’s where we’re focusing new adds.
- The precious metals correction looks finished. Gold and silver broke below the moving average and the prior low to shake everyone out, then reversed sharply back up, the same playbook we saw in the 1970s and in 2006. The correction ran about 140 days, right in line with past ones. The fundamentals never changed while the chart corrected, and we think the producers have another big leg in front of them.
- We’re disciplined, not defensive. We’re holding about 9% cash because summer can get bumpy into a midterm election, and our stop losses are in place. But credit spreads are calm and volatility is muted, so this still looks like a bull-market backdrop. The near-term swing factor is Warsh’s first speech as Fed chair, and markets have a habit of testing a new chair early.