What Financial Markets Are Telling Us: Prolonged Inflation Is Now Baked In And That Means Cash Is King

While consumers fret about spending their cash balances in order to lock in prices today, the Fed and bond vigilantes are ensuring inflation eventually collapses and takes the global economy down to recession in all but name only. After the savage volatility in May investors are taking a breather and sending equities higher, but already the seeds of another volatile leg down have been sown in the bond market via rising interest rates. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), while my technical reading of key stocks in the S&P 500 is short-term bullish. Yesterday's cross-asset action brought one positive factor for US stocks. Copper's chart is signifying global growth. But there were also several negative factors across global asset classes. The US yield curve is rising and in the current context that is bearish. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to rise modestly over the next few days before heading steeply lower next week and into mid-June.

Equity derivatives remains bullish, suggesting that the bulls never capitulated and the May 20 lows at S&P 3810 were not the bottom. Bond market volatility remains elevated and this suggests interest rates will at least retest their highs from early May, if not surpass them. Inflation expectations based on the TIPS market have recently surged from a steep decline earlier in the month, underpinning the volatility of interest rates.

The uptrend in the $US has stalled but looks to resume in the next few weeks. Several EM nations have been struggling to maintain their currencies and now the Japanese Yen has weakened as well, suggesting the rallies in other majors will be short-lived. This redounds negatively to the global economy and portends further weakness in global equities as well.

Inflation may have peaked but the comedown looks to be prolonged due to the war in Ukraine and its consequences for monetary tightening in Europe and across fragile EMs. Commodities are simmering and likely to be remain elevated until the $US resumes its uptrend. Metals are consolidating and within ags and meats there is divergence but no signs of a dramatic fall off like that afflicting lumber. And fossil fuels remain in solid uptrends with no let up in sight, so commodity inflation may be moderating but the flow-through of higher prices will still be worked out on the consumer over the course of the summer.

That underpins rising interest rates and that means lower equity valuations, which marry uncomfortably with continuously declining earnings estimates. I expect a fall to S&P 3700 by mid-June, likely signaling the nadir of valuations and a true bottom in the markets.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.