My job is to tell you, before everyone else, whether we’re going to see reflation or stagflation… and to make sure you know how to position your money and/or your clients, accordingly.
I will continue to watch: 1) Key economic numbers, 2) Key Inflation numbers and 3) Politics, because this will likely be decided in Q1 2017, and getting it “right” early will make a big difference in starting the year right.
I believe this market is headed towards a significant fork in the road, and knowing which turn the markets and the economy take will be critically important for advisors and investors.
Throughout the fourth quarter, the level of peripheral “noise” in the markets has been steadily increasing. But last week was especially “noisy,” with US politics, economic data, European politics and OPEC all producing headlines.
But as we mentioned in this week’s “Bottom Line” (contained in the subscriber only edition of Advisor Cheat Sheet) when you cut through all the noise, the major question facing investors is relatively clear…
Do you expected “Reflation,” or do you expect “Stagflation?”
One of those outcomes will decide where stocks go in the early part of 2017, and that opinion needs to dictate how you are positioned.
Since Election Day, clearly the money has been flowing to reflation, but despite growing optimism, that’s not a foregone conclusion.
Today, I want to review the assumptions for reflation and stagflation, along with the appropriate tactical allocations depending on which outcome you think is most likely.
Reflation: Higher Growth, Higher Earnings, Higher Inflation, Higher Stock Prices
The script for reflation powering stocks higher in the first half of 2017 is as follows:
1. Trump and Ryan cut personal and business taxes
2. And repatriate trillions in offshore cash (due in large part to reduced business taxes)
3. The administration eliminates over-regulation, starting with Obamacare and then Dodd-Frank
4. There’s increased infrastructure spending that provides fiscal stimulus to the economy, and
5. The global macro environment stays broadly calm and unchanged from present day, with no Brexit fallout in March, no “Ita-leave,” no Marie Le Pen victory in France, and no trade conflicts with China.
Under that scenario, growth is ignited, and that acceleration in growth overpowers the headwinds of higher interest rates and a stronger dollar, along with rising inflation.
And, that surging growth combined with reduced taxes helps increase corporate earnings and keeps the market at a justifiable multiple.
Under this scenario, stocks can trade higher from current levels, and materially break through resistance at 2200 in the S&P 500.
Stagflation: Flat growth, Flat earnings, Rising Inflation, Lower Stock Prices
The script for stagflation halting this recent rally in the first half of 2017 is as follows:
1. Implementation of the Trump/Ryan agenda hits multiple speedbumps in Washington and the actual implementation of the agenda is a much more watered down (and/or delayed) version of what’s expected.
2. Growth remains “ok,” but doesn’t experience the intense acceleration that was expected. The mild uptick in growth is not enough to offset higher interest rates, the stronger dollar and inflation, and earnings don’t increase and stocks remain expensive.
3. Geopolitically, Trump’s off-the-cuff tweeting and policy communications unnerves investors and undermines domestic policy actions, creating an unknown that acts as a global macro headwind.
4. Meanwhile, inflation continues to slowly build momentum, forcing global central banks (especially the Fed) to turn incrementally more hawkish.
5. This scenario doesn’t even include a negative macro surprise like “Hard Brexit,” “Ita-leave” or China trade disputes.
Tactical Investment Takeaways
Sector Winners and Losers Regardless of the Scenario: In either case, I think it’s reasonable to expect: 1) Higher rates, 2) Higher inflation and 3) A stronger US dollar.
Expected Tactical Sector Winners: 1. Inflation-linked ETFs (3 ETFs Restricted for Subscribers). 2. Higher interest rate linked plays (2 ETFs Restricted for Subscribers). 3. Inverse bond funds (4 ETFs Restricted for Subscribers).
Expected Tactical Sector Losers: Restricted for subscribers.
Reflation Portfolio: 4 Specific ETFs to Overweight and 4 specific ETFs to Underweight (Specific ETFs Restricted for Subscribers).
Stagflation Portfolio: 4 Specific ETFs to Overweight and 4 specific ETFs to Underweight (Specific ETFs Restricted for Subscribers).
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- The three infrastructure stocks we provided for subscribers have risen an average of 10.07%
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