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ETF Strategy Positions + ISM Misleading?
Welcome to The Observatory. The Observatory is how we at Prometheus monitor the evolution of both the economy and financial markets in real-time. Here are the top developments that stand out to us:
i. ISM Services came in lower but outperformed expectations. The latest ISM Services data showed an expansionary reading of 55.9, implying 8% YoY earnings for the S&P 500. This reading was a sequential deceleration within a decelerating trend. The largest gaining segment was Deliveries, and the most significant slowdown was in Business Activity.
ii. Individual data may bounce or strengthen, but the broad trend in economic data is lower. In particular, ISM data this week surprised expectations significantly, alongside a robust labor market. However, our proprietary High-Frequency Gauges tell us that the trend in economic growth is likely to head lower. Furthermore, when we look at our broad PMI composite, which includes all the major PMI surveys, we see weakness is already present in the form of a downtrend:
iii. Our systems signal heightened nominal growth with a stagflationary tilt. We continue to have the conviction that this is the number one risk to manage in markets today. We show our market regime monitor below:
Over the last month, markets have primarily priced rising nominal growth. Regime Risk is currently elevated, with the potential for a shift to (-) L. We continue to have a dynamic of heightened risk and volatility. Within this context, our ETF Strategy was able to end this week roughly flat, despite significant volatility in equity markets. The performers in the portfolio were high yield shorts (HYG) & natural gas longs (UGA). The drags on the portfolio were silver & TIPS long positions. We show the attribution below:
We show the YTD cumulative return for the ETF Strategy as well:
Our systems continue to tell us that inflation is persistent while growth continues to trend lower. Liquidity conditions have tightened and are likely to get worse. Our systems aggregate our analysis in an algorithmic, rules-based fashion to create portfolios with attractive risk-reward ratios. For next week, here are how our systems are looking to be positioned based on both fundamental and market data:
Stocks: SPY (-5%), XLP (5%), XLY (-3%), XLC (-5%), XLV (5%), XLB (5%), XLI (-5%), XLK (-4%), XLF (-4%), XLU (5%), XLE (3%)
Commodities: DBC (3%), USO (2%), UGA (2%), UNG (2%), CORN(3%), SOYB(4%), CANE(4%), WEAT(2%), GLD (6%)
Fixed Income: HYG (-10%), TIP (13%)
Dollar: UUP (12%)
At the asset class level, our signals net out to an exposure that remains short equities & credit:
This allocation has a probability-weighted loss of -3.1% and a max loss of -6.7% in a three-sigma event. Volatility continues to rise across asset classes, consistent with what we have seen during previous periods of Quantitative Tightening.
With inflation persistent, the growth impulse weakening, liquidity tightening, & volatility rising, capital preservation plus active shorting remains the key to success. We continue to think our systems are well prepared for such an environment as they have been in the past: