I’m afraid my note this week is going to be pretty boring compared to the national headlines. I don’t have much to say about riots in the Capitol, zip ties and spears, narcissistic sore-loser Presidents, fraudulent elections, the horrendous Covid-19 death toll, teacher sick-outs, attacks on the Bill of Rights, snow in Alabama, the nation’s oligarchy of big tech executives, impeachment, or the Cleveland Browns.
Wait a minute; I take that back. …How ‘bout them Browns, dawg?!?
The Browns. And breakeven inflation. The Dollar has surged since the beginning of the year as the Five Year TIPS/Treasury Breakeven Rate climbed over 2% for the first time since November, 2018. In our December 29 note, we suggested that commodities and breakeven inflation had room to run, and I think we’ve only seen the beginning of that. (However, we did not call for the Browns to finally win a playoff game. Missed that one completely.)
Fiscal stimulus prospects increase our bias toward higher interest rates and a falling Dollar. More stimulus may drive additional upside near-term for stocks, but at some point, inflation and high expectations should begin to give investors pause. Ten year treasury yields are rising, and we think they will be above 2% by year end. That will compress market valuations for stocks as big risk premiums normalize.
A rising interest rate environment leads us to emphasize:
Avoiding fixed income mutual funds. Whatever your fixed income allocation is, we recommend filling it with the actual bonds, not the funds that own them.
Complementing high quality core bonds with private credit for potentially attractive yield premiums and diversification benefits.
Moving down in market capitalization to seek exposure to secular growth themes while reducing the concentration and regulatory risk of current mega-cap growth companies.
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