Diversification, Diversification, Diversification
Andy Constan shares what the bond market is telling us right now (and it's very talkative)
Now is not the time for excessive risk-taking, Damped Spring CIO and CEO
told me on Talking Markets last Friday. We’re coming up to a potentially volatile election, the bond market is reassessing Fed cuts, and the price-to-earnings multiple in the equity market hasn’t adjusted to the rise in bond yields. Let’s get into it…All Eyes on Bonds
The bond market is currently reassessing expectations for future Fed rate cuts, Andy said. Basically, the market initially priced in deeper and faster cuts than signaled by the Fed. “The Fed told us [via the dot plot] that they were cutting 50 bps and 25 two more times, and the market immediately took that as they’re cutting 52 more times,” Andy said.
But recent strong economic data (particularly on GDP, unemployment, and inflation) have challenged those expectations, leading to a sell-off in bonds.
“The realization that the scenario painted after the FOMC meeting is on shaky ground is evident in the Treasuries,” he said. Andy’s analysis suggests that 10-year and 30-year bond yields could rise to around 4.5% and 5% respectively, reflecting a steeper yield curve. But he thinks there’ll be a period of consolidation before the next big move.
Easy on the Risk
Andy pointed out a recent spike in the MOVE index, a measure of bond market volatility, which he attributed mostly to the upcoming US presidential election.
However, he also pointed out that long-term volatility in interest rates, particularly in the 1-3 month timeframe, remains elevated, suggesting anticipation of significant events beyond the election.
So, what’s an investor to do?
Well, of course no one can answer that for you. But, Andy said, “The most important thing I can tell you is that most investors, including myself, should be passively long a diversified portfolio of bonds, hard assets like gold, crypto if that's your thing, commodities, equities, and TIPs. The idea is to be diversified and then sit on it for as long as you can.”
And his number one piece of advice:
Trade Ideas
Andy generously shared his current speculative positions (i.e., separate from his core, longer-term portfolio).
Long two-year notes: He anticipates the Fed will meet its currently announced rate cuts.
Short 10-year and 30-year bonds: He expects a steeper yield curve, meaning longer-term bond yields will rise faster than shorter-term yields.
Long S&P 500 and NASDAQ puts: This hedges against a potential decline in the stock market, particularly after the election and earnings season.
Long oil: He is bullish on oil due to anticipated global growth and potential geopolitical risks in the Middle East.
An important note from Andy: “If everything goes to hell, if every single position fails, I'm gonna lose 5% of my AUM. That’s it. I'm a conservative investor, I'm trying to make 10-15% a year in my speculation because I know how hard it is.”
The Return of Inflation?
The Fed's target for core PCE (Personal Consumption Expenditures, a measure of inflation) is 2.6%. Recent CPI and PPI data suggest the Fed might achieve this target, but it will require cooler-than-expected inflation prints in the coming months. So, what does Andy think could heat inflation back up?
Fiscal Stimulus Financed with Quantitative Easing (QE): A large injection of government spending financed by the creation of new money by the central bank (QE) could lead to a surge in inflation.
Supply Shocks: Unexpected disruptions to the supply of goods and services, such as those caused by natural disasters or geopolitical events, can drive up prices and lead to inflation.
Tight Labor Market with Wage-Price Spiral: A very low unemployment rate could force employers to increase wages significantly, which would be passed on to consumers in the form of higher prices, creating a self-reinforcing cycle of wage and price increases known as a wage-price spiral. Supply chain issues have kept this in check so far, but it remains a risk factor.
To watch the full episode, right this way.
Enjoy,
Maggie
Important Disclaimer: It is crucial to remember that this article is for informational purposes only and should not be considered investment advice. Consult with a qualified financial advisor to assess your risk tolerance, investment goals, and determine if an allocation to oil aligns with your overall financial plan.