by cbus20122
Here are some thoughts to consider…
- Oil prices have risen significantly since 2017, but it’s important to consider why they have risen and whether the trend is sustainable. Oil just had a decent pullback at the end of last week which may just be a short term pullback, or could be the start of a longer term downtrend. We will see. With that said, Opec may be loosening up on their supply constraints as they already said that they would do. Aside from the Saudi’s wanting Oil to be high during the Aramco IPO, what other catalysts (aside from a full scale war) are out there that haven’t already been priced in to shoot oil higher? I can see some potential for Oil running higher for a bit, but I don’t think energy is where I would want to be if I were investing with a time horizon of a year or longer.
- Inflation is a huge debate right now, and the market is waffling and trying to figure out whether or not we are in an highly inflationary environment, or if downside risks loom from a deflationary standpoint. While there are clearly some inflationary pressures right now, keep in mind that the broad majority of inflationary pressure has come from rising oil prices alone. What happens if Oil drops back down to early 2017 levels? This will wrong-side a TON of people since there are record positions betting on oil and inflation to be rising this year. Just something to keep in mind from the perspective of risk/reward. If we are in late-cycle right now, things tend to flip from inflationary to deflationary extremely fast (at least, this is the case using history as a guide). I mention this because certain industries and sectors are very prone to being hurt or helped by narratives like inflation.
- Bond proxies (slower growth, higher yield industries typically. REIT’s, consumer staples, utilities) have been doing poorly when inflationary conditions drive the narrative. That script flips when people believe inflation isn’t as bad as suggested. You can view this all in the 10-2 yield curve – note the performance of bond proxies when the yield curve is falling vs. rising, especially in 2018. One extra note here is that consumer staples despite dropping over 30% in many cases are still relatively expensive by most metrics. This is likely due to demographics as well as the fact that they got overpriced greatly by bond investors being pushed into buying these as dividend payers with extremely low treasury interest rates providing little options for fixed income investors over the past 10 years. So while consumer staples may be good traditionally during downturns, they may underperform compared to past recessions if we are to enter into a recessionary environment.
- Technology tends to be fairly agnostic to inflation, which is a pretty good spot to be right now. That’s not to say there aren’t risks here… Valuations in the tech sector are notably high, although technology has also grown earnings more than other sectors over the past 2 years, so a lot of this may be justified. With that said, one thing I’ll note is that a lot of the semiconductor companies (which are heavily woven into tech) lowered their guidance for this year. I still like tech as a broad sector, but don’t be surprised if we see hiccups here.
- Financials tend to be pro-inflation, so if you think we’re going to boom here or that long term bonds are going to get killed, then buying bank stocks or sector etfs is probably smart. I would strongly suggest sticking to USA based financials however… US banks (especially the large ones) are greatly de-risked since the financial crisis whereas most other countries did not enact things like the dodd-frank act as an example. I think financials is a decent sector overall right now to allocate some to, since they stand to benefit from inflationary conditions, but I do not think they’ll get killed like they did in 2008 if we enter a recessionary environment (although that’s tough to say for certain). Yield curve continuing to flatten as it has the past 5 years is a risk to financials however. I’m a bigger fan of financial stocks that deal with financial services for this reason.
- Medical sector is subject to swings and can be politically charged. With that said, medicals are a defensive sector that unlike bonds, reit’s, staples, or utilities can see decent growth and also tends to outperform during drawdown periods. I think the best place to be is medical devices (there is a good etf for that $XHE) right now, although that sector has seen a serious run over the past few weeks, so you may want to let it cool off before you consider getting into it, or average in alternatively.
Obviously there is a lot more to consider depending on how industry specific you get. Also, knowing your time-frame here is a pretty big point of importance.
Disclaimer: Consult your financial professional before making any investment decision.
Views: