June 8, 2022

An Exercise in Trust

 The biggest challenge I have in generating a predictive strategy involves my never ending exercise in trust. Trust of the data, trust of the narrative that interprets it. Needless to say, that’s why I like to simplify my strategy, because strategy, unlike the market, shouldn’t be a rapidly moving target. For this reason, I am drawing attention to what I’m focusing on and how it correlates with current investment exposure to the Industrial, Healthcare and Energy sectors. The biggest challenges that face the capital markets these days are inflation and supply chain disruptions and, in my opinion, the big three culprits where uncertainty reigns are as follows.

The first is the Fed. Inflation is currently being felt domestically in nearly every part of the economy, and clearly being felt by the consumer as recent employment data showed continued hiring (+390K in May) accompanied by a continued increase in employment wages (5.2% over 12mo). This is the tradition of too much money against too few options to buy. But is it more? With clear signs that the economy is slowing in productivity sectors, and retail stores, such as Target (TGT), continue to complain of excess inventory that, in my opinion, has as much to do with lack of consumer interest, then consumer hesitation to buy. In this environment the Fed has not wavered from publicly announcing their intent to increase interest rates when they meet June 14th - 15th. In this light the uncertainty I see is will inflation cease increasing as the economy slows, or when the Fed realizes that the cry of excess retail inventories is a sign of decreasing influence of supply chain disruptions? For now, in my opinion, inflation will eventually stop going up, except when it comes to gasoline, and that’s a problem no one is rushing to solve.

The second is the war in Ukraine. The war in Ukraine and its subsequent initiation of vast sanctions on the Russian economy has led much of the blame for inflation, especially in the energy sector. The current administration has suggested higher gas prices has a positive impact in the transition to electric cars, true, but tell that to the millions of Americans driving for work and play every day. For now, OPEC has no intention of increasing production and most of the countries whose economies are dependent on oil production also happen to be controlled by dictators and authoritarian governments. Hence, my concerns are Ukraine is an excuse for now, but the bigger uncertainty is the potential for escalation of the conflict and what it means for continued rise of China in the Pacific region.

The third is China. The past 12 months have made for very abstract observations. First has been the decimation of the economy, both from the lockdowns from its zero tolerance Covid policies and the second from its crackdown on the technology sector of its economy, one which it spent decades growing. But one area that is ignored by the west is the number of products, pharmaceuticals, medical devices and commodities such as steel, copper and various food products are all huge exports from China. In my opinion, any repatriation of these industries would go far in reducing dependance and therefore intended consequences such as inflation and supply chain disruptions. This is a big uncertainty for the global economies.

The shorter term technicals are moving from oversold to neutral territory without much overall market improvement to show for it. Economic data keeps coming in mixed and the next few weeks could still see some overall improvement in the broad indexes. Most of this will come from indications that after the Fed meeting, treasury interest rates could come down. In addition, the end of a quarter traditionally sees buying, otherwise referred to window dressing, that should see a pick up in the move out of growth into value sectors, such as Healthcare and Energy. Both would keep the markets steady as technicals could slowly move from neutral to negative for the summer. Until then, cash remains our friend.

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