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Real Growth Trend Still Weaker
Welcome to The Observatory. The Observatory is how we at Prometheus monitor the evolution of the economy and financial markets in real-time. The insights provided here are slivers of our research process that are integrated algorithmically into our systems to create rules-based portfolios.
We’ll keep it brief today.
i. Real income is continuing to fade, and we expect this trend to continue lower. Below, we show one of our high-frequency income gauges that continues to show that we are in a slowing real growth environment:
Nominal growth will likely remain elevated on a year-over-year basis, but as real growth goes into negative territory, we expect more pain to set into markets and the economy.
ii. Inflation is likely to remain elevated through the year, but decelerations are likely ahead of us. Commodity prices, investment markets, and liquidity conditions are all showing an increased likelihood of slowing inflation rates.
As we can see above, the divergence between our gauges and realized CPI is large, suggesting the potential for deceleration is significant. We will offer guidance on the specifics of the inflation print in our Week Ahead note.
iii. Markets remain in a tightening liquidity regime, though we should note that we have seen a significant resurgence in the odds of stagflationary nominal growth.
Our systems combine the underlying principles in our analysis into rules-based portfolio construction and continue to tell us to remain defensive in our exposures after being aggressively short equities & credit. Our systems estimate that the worst of the inflation shock is behind us. These dynamics create an environment where generating alpha via equity shorts becomes more challenging, but bond beta becomes easier to harvest. Resultantly, our systems are now significantly allocated to deflationary & tightening liquidity assets (Treasuries, MBS, Dollar, & Cash). However, our risk mitigation signals have also moved us towards marginally higher exposure to commodities, providing us protection from ongoing inflation. We show our Alpha Strategy asset class allocations below:
There will likely again be opportunities to generate outperformance on the short Quantitative Tightening accelerates, and we will wait for our systems to guide us. Stay nimble.