"Inflation Hedge" Bros are coming

How lopsided positioning is vulnerable to a change in Narrative around reflation

People’s market narratives in making sense of what they see are usually late, or even backwards. Nobody cared about term premium and bond issuance in 1H23, and suddenly in Q3 it mattered (and bonds cratered)…just at the time one should have started worrying about growth.

The move back down in long-term bond yields since Q3 is really about growth — and the Fed blessed this view in December (remember the Fed is always late). But like the market, people are skating to where the puck is now, or the wrong puck entirely. They should be thinking about Inflation/Reflation now, but instead we get the following consensus views around the Growth narrative (all charts BAML):

And not surprisingly, these views naturally translate into the following consensus positioning:

And in relation to other assets, it’s all about fixed income, all the way (and corresponding defensive positioning in equities):

The issue of course is that a mild recession is priced in, and/or hard landing is well on its way to being priced. This is the consensus. Big money is not made in the consensus. Pedestrian, subpar returns accrue to the consensus.

Do you know what’s not priced in and nobody cares about? A wage price spiral in 2024 that causes people to justify ex-post an equity & gold rally (and bond selloff) that coalesces around “Equities are a good inflation hedge,” or what I will call Inflation Hedge Bros. They’re coming.

The Inflation Hedge equity bull narrative is just being born now. Their arrival will occur in parallel with another selloff in the long end of the curve. And while this may seem consensus to some, the focus on the equity side remains 1) Small/midcap; 2) Cyclicals; 3) Value; 4) Commodities; 5) EM (particularly low-multiple EM).

Thanks for reading,

PauloMacro aka CloudBear