Inflation’s Coming in Hot!

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

TIPS versus Treasuries is one of the most important charts we’re watching right now, as it's hitting its highest level since early 2013. Relative strength from TIPS hints that investors are positioning themselves for a sustained surge in inflation.

This makes sense given both the five- and 10-year breakeven inflation rates have reached their highest levels in more than a decade. 

As investors react to signs of impending inflation, many cyclical stocks that benefit from higher rates are catching a bid. A great example of this is the Metals and Mining ETF $XME.

Let's take a look!

Below is a chart of XME overlaid with the TIPS versus Treasuries ratio and correlation study in the lower pane:

If investors are anticipating higher inflation in the future, the ratio will have an upward bias. That’s exactly what we’re seeing. 

When there is inflation and strong global growth prospects, metals and mining stocks tend to perform well. This is illustrated by the strong positive correlation shown in the bottom pane.

Long story short, the new highs in the TIPS-Treasuries ratio suggest we’re likely to see new highs from XME in the near future. We can take it a step further and apply these implications more broadly to cyclical assets in general.

Think materials, homebuilders, and industrials, all of which are making new highs. Add energy, financials, and commodities to the list, as these too should catch higher in a rising rate environment.

The bond market is sending us a clear message: Inflation is coming. Our job as investors is to turn our attention to those cyclical value areas of the market that benefit the most from rising rates.

We’ll continue to focus on these areas of the market, highlighting long opportunities as well as updating crucial information coming from bonds. 

Stay tuned!

Thanks for reading. As always, let us know what you think.

And be sure to download this week’s Bond Report!