When you look at the market since the beginning of the year, the perception is that the U.S. economy is really moving into durable-recovery phase, and you had a rotation away from emerging markets to developed economies. If you look at the emerging markets vis-à-vis the S&P [Standard & Poor's 500], the S&P has really outperformed. One of my favorite trades would be to rotate back the other way. People are going to discover the view about the durability of the U.S. economy is overblown, and they will rotate back toward emerging markets.
What other trades make sense?
Clearly, at a time when consumers don't have wage income and they seem reluctant to borrow, there isn't a lot of room for them to pay higher prices. So I view the commodity-price inflation as really a major margin squeeze for the corporate sector, more so than anything else. That's another theme I would play by selling or being underweight small-cap stocks, which have been just on fire. I would definitely overweight large- caps vis-à-vis the small-caps, which are really going to be most vulnerable to these kinds of pricing pressures.
At the top of my list, I would be long hard assets, including gold and Treasuries, on the expectation that people will be disappointed by the economic data coming up, in part because of the seasonal and statistical issues that I mentioned previously.
If you look at the speculators, they had a huge long position in Treasuries at the end of last year, but they've flipped them into a really sizable short position in just a couple of months.
Are there any other themes that come to mind?
Another is related to consumer discretionary spending, which, again, is an area where disappointment would be particularly punitive. I would be looking to short some of the discretionary stocks, including XRT [SPDR S&P Retail], an ETF that gives investors exposure to retailing. And with this mortgage reset wave unfolding against a backdrop of higher food and energy prices and consumers who don't have the government support from transfers and stimulus anymore, I would be looking to short the financials again. I think we are going to have some mortgage mayhem.
This is all pretty gloomy. Any potential silver linings?
The best-case scenario -- and what Ben Bernanke is working really hard on and what hopefully will happen -- is that by inflating assets, even nominally, and getting the equity market to recover a lot of the ground that it has lost, high-end consumers will feel emboldened to go back out and spend. And since they really drive marginal consumption in the economy, eventually their spending will motivate companies to go out and hire and really feel better about expanding or believe in the durability of the recovery. So that's the hope. And every time you get some glimmers of life at the high end, it is very exciting. And then, all of sudden, it looks like it dissipates. So we'll have to see. For me, the next couple of months will be critical, as we see the stimulus come off and we get into the challenging year-on-year comps and we get a real sense of the economy's ability to stand on its own two feet.
---Barrons, this week. Other good things at the link. Subscription rqd.