As the new financial quarter gets underway, investors should start paying attention to the different price action themes across asset classes today. While far from the ultimate gauge to predict future themes, these trends and divergences can help develop reasonable scenarios for the economy moving forward.
Today, major divergences are happening across the bond market, commodities, technology stocks, and other areas of the economy to signal an ongoing theme in the economy. Be that as it may, two mega investors in the United States are already pushing for these themes to play out, with “all roads” leading to one outcome, as one of these investors said.
The key assets to watch are interest rate-sensitive bonds through the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT), the basic materials sector with a focus on gold through the SPDR Gold Shares (NYSEARCA: GLD), particularly after its recent all-time highs, and the SPDR S&P Regional Banking ETF (NYSEARCA: KRE) and its reaction to the bond market.
Divergence Between Bonds and Small-Cap Stocks Sends a Warning to Investors
Typically, when bond yields come down (due to interest rates coming down), small-cap stocks will start to outperform as they depend on lower rates and flexible financing to expand and see their margins rise. Knowing this, the behavior between the iShares bond ETF and the iShares Russell 2000 ETF (NYSEARCA: IWM) raises some flags.
Over time, correlations and fundamentals have proved that small-cap stocks should go up along with this bond ETF, knowing that this means rates are on the decline and thus helping the macro picture for small-cap stocks to start outperforming again.
This has not been the case during the past quarter, as the bond ETF has retraced from recent highs while the small-cap ETF has remained near its highs. This could lead to an inflation scenario, something investors need to keep in mind moving forward, as it pushes for stock selection criteria that look more like growth stocks than anything else.
Investors can come to a similar conclusion regarding inflation when watching the regional banks, which are extremely sensitive to yield curves and interest rates. Just like the small-cap stocks ETF, this space has slowed down its uptrend significantly, creating a divergence from the bond ETF and a warning sign that points to added inflation ahead.
More than that, this behavior can be confirmed through the gold ETF’s price action, which suggests inflation trades could be coming back on. Knowing this, other spaces like the energy sector could be attractive, which is why Warren Buffett bought up to 29% of Occidental Petroleum Co. (NYSE: OXY).
Others on Wall Street agree. Stanley Druckenmiller and Paul Tudor Jones have both recently warned about inflation and are shorting bonds and buying commodities during this cycle. Before considering a buy-in in commodities or commodity-related stocks, investors need to understand the implications for other popular stocks today.
Growth Under Threat, Other Market Wild Cards at Play
Druckenmiller, apart from shorting bonds, has also gotten rid of his NVIDIA Co. (NASDAQ: NVDA) stake recently, and even Buffett decided to get out of 50% of his Apple Inc. (NASDAQ: AAPL) stake recently.
Looking at the relative performance of the iShares S&P 500 Value ETF (NYSEARCA: IVE) and the iShares S&P 500 Growth ETF (NYSEARCA: IVW) also suggests that growth stocks might be threatened by this inflation trend. If these trends keep gaining momentum and market interest, then there’s also something else (sort of a wild card) to watch for in the coming quarters.
Oil prices have struggled to break above $80 a barrel, countering other inflation trends already seen in the markets, creating a tail risk that oil prices suddenly spike. Now, this is where the wild cards come in, specifically through geopolitical risks that could suddenly escalate to bring the price of oil to a more inflation-reflective level.
The recent price action in shares of Lockheed Martin Co. (NYSE: LMT) gives investors a glimpse of how this could be the case soon, mainly as the company delivered a 12-month performance of up to 26.1% today, and with some on Wall Street expecting to see the stock rally by an additional double-digit pace this year.
Analysts at Susquehanna have recently reiterated their “Positive” rating for Lockheed Martin stock, with a price target of up to $695 a share. To prove these valuations right, the stock would need to deliver a jump of as much as 23.6% from where it trades today, not to mention a new high price for the year.
Considering all this, investors could watch for further developments between the small-cap stocks ETF, the bond ETF, and especially gold and oil when it comes to commodities. So far, all of their price action suggests inflation risk ahead, so any divergence from this trend could signal the potential for other outcomes, turning crucial for different sectors and asset classes today.
