As we think about the next steps in our tactical rotation process, we are looking for clues as to where the triggers may be hiding that will push the next asset class to the front of the pack. This is especially true considering the extremely extended investor sentiment that now exists in U.S. stocks. We care because, as the following chart shows, when sentiment reaches extremes markets often pull back or rotate to different sectors/regions that are not as fully valued. We believe the stage is set for this type of rotation.
Source: Ned Davis and Associates.
Following June’s strong inflation data (driven primarily by used car pricing), the ongoing improvement in the labor markets and record liquidity, we believe the Fed’s announcement about reducing its bond purchases, the proceeds of which are used to stimulate the economy, could be made at its annual Jackson Hole symposium in late August.
Today’s release of the Consumer Price Index (CPI) showed a jump of 0.9% in June, the most since the summer of 2008, and nearly double analysts’ estimates of 0.5%. Like the past several months, more than a third of the increase was attributed to a record 10.5% jump in used car and truck prices. The used car market has been strangled by strong demand as the economy has reopened and supply constraints have forced a premium on the vehicles that are available. The balance of June’s increase was broad based. Looking forward, low manufacturing inventories and shortages in both raw materials and labor suggest that pricing pressure will continue for some time to come. This should relieve the Fed of any lingering deflationary concerns.
In the Fed’s latest policy report, it recognized that the labor markets had improved substantially in the first half of the year which, in Fed Speak, may well be signaling that one of their chief requirements for beginning to remove stimulus is in the process of being satisfied. Assuming employment continues to improve over the next few months, this is a box that we may consider checked.
The Fed’s dual mandate concerns both pricing and labor. If both of those objectives are being met, as they appear to be, it is reasonable to believe an official announcement concerning tightening will be coming at the upcoming meeting. That we believe would offer the trigger for rotation.
HCM remains underweight foreign equities in our globally diversified portfolios, however, that may change in the coming months if the Fed makes the announcement we expect. We could move sooner if the market begins to anticipate this action and the relative strength of foreign securities, more specifically, European securities begins to shine. Our view of European equities has improved because of the broadening restart of the EU’s economy. We expect a pickup in activity spurred on by accelerating vaccinations and the economic stimulus the ECB will continue to provide after our Federal Reserve has started to throttle back. Valuations remain attractive in Europe relative to both the U.S and history, and investor inflows into the region are only just starting to pick up.
Stay tuned as the developments materialize over the next few weeks.
| Mike Hengehold, CPA/PFS MST RICP®
Mike is the Founder and President of HCM Wealth Advisors. Over the last 30 years, he’s provided financial planning guidance to a myriad of families to help them realize their financial dreams. Mike is an avid homebrewer and animal lover, and when he’s not at work you can often find him on the golf course working on his short game.