The Sleep Well Portfolio at a Glance - 1/10/23
Volatility Continues to Build
SPY (Large Caps)
We have finished our first full week of 2023. Has the market crashed yet? Yes. What does a crash feel like when we are in the beginning? Exactly like this. Markets tried to have a run-up and failed at resistance (3900-3940). The stories this year are most likely going to be dominated by falling inflation. The thing about falling inflation is that historically it is not good for stocks. Why is that? If inflation is falling due to a tightening cycle it is most likely from falling demand. When demand falls so too does earnings. We are about to get reports of earnings on Friday and our models have a high probability of overall contraction in revenues and earnings across the board. Historically this has led to further downside in the market. We are not fooled by the false rallies. The SWP and AWAKE remain not bullish on US equities.
One Month Risk Calculation – Risk Increasing
TLT (Bonds)
As bonds attempted a correction from their recent meteoric rise from the depths of hell, we get our first signal that we are in a confirmed collapse stage for assets. From now on bonds, gold, EEM, and UUP will dominate the portfolio until later this year. Of course, we will adapt Much as our options do with the ADAPT SPX. That means we will still get fluctuating allocations to TLT but the bottoms are most likely in albeit with some more volatility to come.
One Month Risk Calculation – Risk Unchanged
GLD (Consumer Goods Inflation)
When does gold have its best years? When the Fed is moving from a tightening stance to a loosening stance. That is what we have in place for 2023. The Fed is likely to spill rhetoric that they will fight inflation and that they will not stop till the job is done. Yeah, yeah we have all heard that before. In reality, they are caving to the pressure. The Fed minutes that were released last week stated that they could slow down interest rate hikes to 25 bps. We follow the data and know what it says. The bond market is pricing in a stalling and a dropping of interest rates all year. This is great news for gold, as inflation is high and fed rates dropping or stalling, MMMMMM mighty tasty macro investment we have here! Sure it is at the top end of the range but I would not short this asset in the collapse stage with above-average historical inflation.
One Month Risk Calculation – Risk Decreasing
UUP (US Dollar Relative Deflation)
Overall UUP is a great asset during the collapse stage historically. The one thing about this asset is that it really depends on relative inflation. Recently The Fed is the first to ease because the inflation in the US is relatively lower than most of the world. Due to this, we had a small spat of Dollar devaluation but overall the Dollar will likely have its hay day again in the depths of this recession in the first and second quarters of 2023.
One Month Risk Calculation – Risk Unchanged
IWM (Small Caps)
Small caps are very financially heavy. In a falling GDP, Decelerating Inflation, and Falling Relative inflation financials typically underperform all other equities outside of tech. We will see how this double-dip recession plays out but the endpoint is that we are not long IWM and it will likely remain that way unless we get some strong risk on signals.
One Month Risk Calculation – Risk Increasing
EEM (Emerging Markets/ Relative Inflation)
It's back baby! We have been talking about EEM for months now and that it will be one of the greatest assets to have in late 2023. Well, the capital flows out of the US into emerging markets and China has dramatically shifted our models early. This is due to a dovish Fed and the risk of the Dollar losing its status. We are likely watching the death of the USD play out and the largest winner will be China. As an investor, it is nice to diversify but we are still on edge due to an overall global recession happening right now.
One Month Risk Calculation – Risk Unchanged
Drivers for Current Portfolio Allocation
We are in the midst of a global recession. First, it was a supply squeeze, then it was a spike in inventories. But wait wasn’t it supposed to be transitory? Inflation is always transitory… but when the Fed is the one that governs inflation and fails to act, inflation will become entrenched. The Fed failed to act in time in 2020 and allowed the bubbles to form. Now we have to pay the price.
So far YOY CPI is unphased by the meager attempts to raise rates. It is going to take a lot more cowbell to snuff this inflation spike out. The government is still spending at breakneck speeds and is making the Fed's job harder. That means more rate hikes coming and higher inflation for longer. The very thought of a Fed easing up on interest rate hikes when inflation is at 7% is pure lunacy. But that is what we have.
When the rates fall or stop in the face of high inflation it devalues currencies. If the Fed continues to be behind the curve this is what will happen. The cost of money will go up and the value of that money will drop. This is the doomsday scenario that could play out. On the other hand, it is entirely possible massive productive output growth will dramatically drop inflation for the Fed, just as we did in the 90s with the internet boom. Today it would likely come in the form of AI, but we will see.
One leading indicator to recession is C&I loans. This is one metric we look at in our models to determine if there are tightening credit conditions. When C&I loans become harder to get or more expensive it leads to slower growth, which leads to fewer jobs, which leads to less spending, which leads to tighter credit conditions, which leads to slower growth. This cycle will continue until credit conditions ease whether it comes from the central bank or banks in general it will mark the beginning of a new credit cycle. That time is NOT now. Things continue to get worse, not better, welcome the “Collapse Stage”. On a positive note, it means we are closer to the next bull market. When credit conditions ease so to will the pain, albeit with some residual momentum.
May you ADAPT to markets and Sleep Well,
SWP Team
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