A Multi-Trillion Dollar Migration of Capital to Inflation Assets?

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Jennifer Sor of Business Insider reports a multi-trillion-dollar bull market is coming for assets that benefit from higher inflation, top macro strategist says:

There's an enormous bull market coming for assets that will benefit from stubbornly high inflation, according to top strategist Larry McDonald.

The "Bear Traps Report" author and former head of US macro strategy at Société Générale cast a warning over high prices in the economy, predicting that inflation would remain consistently above the Fed's 2% target for years to come. Prices will likely range between 3%-4% over the next decade, he predicted in a recent interview on Blockwork's Forward Guidance podcast.

"You've got all these sources of sustained inflation coming at us," McDonald said, pointing to price pressures stemming from reshoring, government stimulus, and a strong labor market.

Those pressures are exacerbated by the fact that geopolitical conflict is on the rise. War itself is inflationary, McDonald said, pointing to the stagflationary crisis in the 70s that coincided with the Vietnam War. 

"So we're coming into this more sustained inflationary regime," he warned.

But that could actually be good news for "inflation beneficiaries" — or areas of the market that will actually soar as prices remain elevated. Those beneficiaries include assets like nickel, aluminum, uranium, copper, gold, oil, and gas, McDonald said, estimating that the energy grid alone was likely worth around $2 trillion.

The shift will pull a tremendous amount of money from popular growth stocks, like the Magnificent Seven, to hard assets and commodities, he added. Some of those assets are already seeing an uptick in interest, with gold prices surging to a record high this week. 

"We're talking about a multi-trillion dollar migration of capital and nobody's prepared for it," McDonald said.

Investors, though, are largely expecting inflation to return to back to its long-run target over the next year. 1-year inflation expectations dropped to 2.07% in March, according to the Federal Reserve Bank of Cleveland. Prices have already cooled dramatically from their highs of 2022, with consumer prices rising just 3.2% in February.

McDonald is among Wall Street's most bearish prognosticators at the moment, repeatedly sounding the alarm on stocks and the path of inflation. In March, he predicted the stock market could crash as much as 30% over the next two months, thanks to the impact of higher interest rates on the economy. He made the same prediction in 2023, the year stocks actually soared 25% higher.

Alright, Friday afternoon and time to talk markets and focus our attention on an important macro theme, namely, are we on the cusp of another 1970s style inflation boomerang?

If you've been paying attention to commodity markets lately, that seems to be what the market is hinting at (source: Trading Economics):


Many commodities are making a record high including gold prices surging to record levels (source: Trading Economics):

And long bond yields keep creeping higher as the economic data comes in better than expected and the federal deficit swells:


So what is going on? Is this just all about geopolitical tensions or is the market sniffing out a new, more sustained inflation regime that Larry McDonald is warning of?

Well, that's an important question because if we are indeed on the heels of another 1970s-style inflation episode, it means inflation expectations will creep up along with rates and that has implications for pensions managing assets and liabilities.

On the positive front, an increase in rates means a better funded status for corporate and state pensions.

On the negative side, a sustained higher inflation regime will usher in higher rates for longer which means some assets like nominal bonds and real estate will continue to struggle.

I discussed some of this in a recent comment here.

In public equities, higher rates will hurt high yielding stocks which many retirees count on to make extra income during retirement (stocks decline, yields go up but capital losses swamp that extra yield).

So where are pensions to hide in a higher for longer environment?

Well, commodities (including agriculture), infrastructure where contracts are indexed to inflation, natural resources, private equity (selectively) and private credit where rates are floating.

Are there any structural deflationary forces out there?

Yes, there are plenty. Global debt levels are at record levels, aging demographics, there's a looming retirement crisis in China and around the world, artificial intelligence is on the rise and quite frankly, we are one financial crisis away from the next deflationary episode.

The Fed has a lot of challenges to navigate here and I fear those challenges will become more evident in the second half of the year.

Given the better than expected economic data, it's not surprising that some Fed officials are dialing back rate cut expectations:

But if you sratch beneath the surface, you'll see the US economy is slowing:

And even in gold, miners aren't confirming a breakout here:

All this to say, take all inflationary or deflationary macro calls with a grain of salt here, we simply don't know how events will transpire in the second half of the year.

Betting on a multi-trillion dollar migration of capital into inflation assets might pan out, but if it doesn't, those investors will suffer steep losses.

Below, James Bullard, Purdue University's Business School Dean and former St. Louis Fed President, joins 'Squawk Box' to discuss the March jobs report, the impact on the Fed's interest rate path, state of the economy, and more.

Second, Lawrence H. Summers, former US Treasury Secretary and Wall Street Week contributor, says the evidence is overwhelming that the neutral rate is higher than the US Federal Reserve supposes and says it would be a policy mistake for the Fed to cut rates in June. Summers speaks to David Westin.

Third, Jeremy Siegel, professor of finance at the Wharton School, joins CNBC's 'Closing Bell' to share his reaction to the March jobs report, potential rate cuts, and earnings expectations.

Fourth, Ralph Schlosstein, Evercore chair emeritus, discusses the state of the US economy, wealth disparity and geopolitical risks with Alix Steel and Romaine Bostick on Bloomberg Television.

Fifth, Seth Harris, senior fellow at the Burnes Center for Social Change, joins CNBC's 'Power Lunch' to breakdown the March labor data, economic outlook, and more.

Sixth, Diane Swonk, chief economist at KPMG, and CNBC's Steve Liesman discuss Friday's higher-than-expected jobs report and what it means for the Fed and markets.

Seventh, Tiffany Wilding, Pimco's chief US economist, says the US economy is running hot and the Federal Reserve can wait on rate cuts.

Eighth, Federal Reserve Bank of Minneapolis President Neel Kashkari says interest-rate cuts may not be needed this year if progress on inflation stalls during a virtual event with LinkedIn.

Ninth, Federal Reserve Chair Jerome Powell reiterated Wednesday that the central bank expects the need to cut interest rates this year, despite the recent stronger-than-expected economic activity. Photo: Loren Elliott/Bloomberg News.

Lastly, take the time to listen to Larry McDonald, founder of The Bear Traps Report and author of the book “How To Listen When Markets Speak: Risks, Myths, and Investment Opportunities in a Radically Reshaped Economy,” as he speaks with Julia La Roche to discuss why he thinks trillions are misallocated.

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