Welcome to the Slowdown: Moves to Make Ahead of Stagflation
Tuesday’s massive Consumer Price Index data confirmed the inflationary pressures we’ve been talking about for a year.
And Wednesday’s Producer Price Index confirmed that inflationary pressures are still with us… they’re merely shifting around.
In my Fortune Research Pro service (if you’d like to sign up, just click here), I told subscribers just a day ago that:
“Since PPI is a leading indicator of CPI, it means in turn that these inflation figures are going to stay a lot higher for a lot longer than certain Central Bankers are prepared for.
Technically, I suppose that qualifies as ‘transitory’ — meaning strictly ‘not permanent.’
But the data is telling us there’s one thing this inflationary period won’t be…
Fleeting.”
And now with U.S. Gross Domestic Product (GDP) set to post the highest growth rate in many of our lifetimes when the second quarter gets reported on July 29, there’s only one direction it can go from here.
Down.
Yes, it will be peaking due to base effects. And yes, there will be more people forced to enter the workforce as their benefits run out. And yes, their wages will go up when they do so.
We’ve been seeing that since February, as total unemployment claims (including Pandemic Under Assistance) have been falling steeply.
Source: Bloomberg
That should continue to accelerate downward over time, finally getting below the prior peak during the Global Financial Crisis by the end of summer.
Now don’t get me wrong, falling unemployment is an incredibly good thing for the broader economy, and the accompanying wage growth is long overdue.
The problem is that inflation has been so persistent — particularly for food and other goods — that wage increases are going to be at least partially offset by higher prices.
That might not matter for the wealthy, but it matters to everyone else.
And in turn, that matters to real economic growth (which subtracts inflation), because relative consumer spending declines, taking roughly 60-70% of GDP down with it.
Those two factors — declining economic growth amidst persistently high inflation — means that the U.S. economy is headed into a period best described by a nasty, nasty word…
Stagflation.
Time to Make Some Portfolio Changes
Moving into a stagflationary economic environment requires us to think differently about the kinds of stocks we should be interested in for at least the next six months.
For one, larger companies — mid caps and above — tend to do better than smaller cap stocks.
Stocks with lower volatility (or low beta) tend to perform better than those on the higher end of the volatility spectrum.
Some sectors (Tech, Utilities, Commodities) perform better than others (Financials, Communications).
For us, that means first we need to say goodbye to a few favorites that we’ve posted some big gains in over the months, some recent speculative stakes that we’ve put on that have now been rendered moot, and some that have just flat out sucked.
Then we need to take profits on things we still like in the next phase of the economy, but that have run up in price.
Let’s get started.
We still like the long-term prospects for shoe retailers Designer Brands Inc. (NYSE: DBI) and Caleres (NYSE: CAL), but we want to reduce exposure to small caps, so selling half the overall position at a small gain for DBI and a small loss for CAL is the play there.
We will come back to them during earnings season.
I am also recommending we remove the Direxion Daily Small Cap Bull 3X ETF (NYSEArca: TNA) entirely at about a 5-6% loss, as that was a speculative play that has not worked out, and the Russell 2000 appears to be breaking down.
Price action in the U.S. Dollar Index is going to fluctuate, and appears likely to stick around this level, so we are closing the Invesco DB US Dollar Bullish Fund (NYSEArca: UUP) short at a small gain of roughly 0.3%.
Financial companies fare worse when interest rates don’t go up, so we’re closing our stake in Goldman Sachs (NYSE: GS) at a 15% gain.
Copper prices are either consolidating or getting ready to break down, and I can’t tell which. Prices are heavily dependent on robust Chinese purchases, and the Chinese economy frankly looks like garbage. As such, we’re pulling our three amigos — Freeport-McMoRan Inc. (NYSE: FCX), Ivanhoe Mines (OTC: IVPAF), and the United States Copper Fund (NYSEArca: CPER) — from the portfolio at as much as a 22% gain for the final leg.
When small-cap companies don’t do well, neither do their underlying bonds, so we want to pull off any positions in the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) at a small 1% gain (plus dividends).
We also need to eliminate all the stinkers. And as much as I liked (and frankly, still like) the long-term cannabis plays in both the AdvisorShares Pure US Cannabis ETF (NYSEArca: MSOS) and Jay Z-driven TPCO Holding Corp. (OTC: GRAMF), they have been awful, down 7% and over 25%, respectively.
Kick ‘em to the curb.
Similarly, our travel and gaming plays on low-cost Spirit Airlines Inc. (NYSE: SAVE) and high-upside Boyd Gaming Corp. (NYSE: BYD) are just not working out, down a respective 22% and 8%. Their fundamentals are fine, and their revenues will grow at a great pace.
So maybe we will revisit them during earnings season… But for now, it’s time to say “buh-bye.”
And finally, we should take profits in successful trades that have run up, including a 2% gain in half our position in Proshares Ultra Silver (NYSEArca: AGQ), a 6% gain on ½ our position in Proshares Ultra Gold (NYSEArca: UGL) and an 8% gain on our first two stakes in Invesco QQQ Trust Series 1 (NYSEArca: QQQ).
That leaves the remaining open Venture Society portfolio looking like this:
Source: Venture Society
We’ve got exposure to utilities, commodities, industrials, tech, gold, targeted real estate and growing retailers… I like it.
One last move, though, as cryptocurrencies are either breaking down, or they’re consolidating and about to ramp back up. As such, I’d like to pick up another speculative quarter stake in the Grayscale Bitcoin Trust (OTC: GBTC) and a quarter stake in the Grayscale Ethereum Trust (OTC: ETHE).
If Bitcoin drops below $30k and sticks (about a 5% fall), we’re out.
Similarly, if Ethereum drops below $1,850 and sticks (a 2.3% drawdown), we’re done with it.
To ensure this, I would recommend setting hard stops at $24.68 for GBTC, and $17.10 for ETHE.
In addition, from here until further notice, we’re likely to buy any dips in gold and silver unless there is a clear physical reason not to.
And if we get any real pullbacks… We’re backing up the truck.
All the best,
Matt Warder
