Any weather is Pepsi weather

According to the Bloomberg hedge Fund Index, hedge funds had their worst month in June since 2020. The New York Fed Survey of Consumer expectations for US stock prices to be higher in a year’s time has fallen to their lowest level for almost a decade. A report from Deutsch Bank has futures positioning as bearish as it has been since 2019, by some margin, to the point where positioning is now net short. Their Z score for consolidated equity positioning has only been lower during Covid and the euro crisis in 2012. Everyone is apparently prepared for the next leg down in stock prices.

The max drawdowns for stocks when valuations have been high and we have had even a mild recession has been as much as 40%. If some economists are right we are only halfway through this bear market. If, on the other hand, we avoid an economic recession the current drawdown is probably enough to reflect the recent economic slowdown. Earnings reports in the coming weeks along with the outlook statements with have an impact. To that point Pepsi Cola kicked the season off on a positive note, for consumer staples at least, demonstrating pricing power as they raised their revenue forecasts for the second time this year.

US treasury prices have stabilised, but the 2-year ten-year yield has now inverted, having come close on several occasions. With yields of around 3% from two through to ten years for US treasuries, there is now a credible alternative to stocks, which is not all bad allowing more balance to the portfolio. UK gilt yields have moved up but as yet do not offer quite the same value. However at the shorter end, with two-year yields close to 2% that does allow for modest diversification during these uncertain times. TINA, there is no alternative, to stocks is now not so much the case. Even some household names’ corporate bonds now have yields attractive enough to offer further diversification away from stocks.

The rapid change in US inflation expectations can be clearly seen with the Fed five year five year forward inflation expectation for the US was at 2.75% not many months ago, it is now back to 2%, as can be seen by the chart below.

The one unexplained is the ongoing strength of the USD against all other currencies, as it continues to climb higher. The lowering of inflation expectations which has led to falling interest rate expectations should have weakened the dollar, this has not occurred. A more sustained rally in US stocks is unlikely to occur until the dollar starts to sell off. That may not happen until we get some evidence from the Fed they are prepared to take their foot off the QT pedal.