Inflation looks hot! Get ready to short tech if bonds break downWatch for bond breakdown as a Nasdaq sell signal
Early this year, the Nasdaq had its weakest run in a long time as interest rates rose (and prices fell) on the 10-year US bond. (Note that bond rates and bond prices move in opposite directions.) Both tech and 10-year bonds have rallied a bit since March, but amid heightened inflation expectations this week, I've been watching like a hawk for interest rates to begin rising (and bonds to begin falling) once again. I'd expect to see tech begin another large correction should bonds fall through their uptrend support line, which they're testing right now:
Signs that inflation is about to get hot:
1) Bloomberg and Arbor Data Science report more than 50% odds that headline CPI exceeds +2.5% year-over-year. That's the highest those odds have been in a long time.
2) Commodities like lumber and corn and copper continue to roar. Save your unpopped popcorn kernels, because corn futures are starting to look like a Tesla or Bitcoin chart:
3) According to Bank of America, "The number of mentions of ‘inflation’ during earnings calls also rose sharply, more than tripling YoY per company so far, the biggest jump in our history since 2004." According to CBS News, Procter & Gamble says it will raise prices in September. Other companies discussing price hikes include Kimberly Clark, Owens Corning, Mohawk Industries, Shake Shack, and McKesson. It's hard to deny that inflation is coming when companies are explicitly telling us that they will raise prices.
Signs that rate hikes are coming as well:
1) Rates are rising all over the world, not only in developing nations like Turkey, but also in developed nations like Russia. Rising rates signal that inflation is expected, and rising rates abroad put some competitive pressure on US rates to rise as well.
2) U.S. economists think the Fed will start tapering monthly bond purchases later this year, earlier than they previously thought. In other words, to control inflation, the Fed may end its policy of "soft yield curve control."
Financial conditions drive markets
We've just lived through an unprecedented bull market due to never-before-seen loose financial conditions. However, the bonanza may soon be over if inflation and interest rates heat up. Tightening financial conditions could lead to not just a sharp Nasdaq correction, but perhaps even a prolonged bear market if they last a few years.
With the Nasdaq poised near an all-time high and bonds right on the verge of breaking down, having slightly violated their support line today, I think at minimum I'll hedge with a Nasdaq put. Note the double top that may be forming in Nasdaq here.
Disclaimer: not financial advice.
