Stocks are falling because the economy is too strong and the market is actively pricing out rate cuts in 2025.

This is creating a "short-term pain = long-term gain" setup.

The key risk here is inflation, only from a Keynesian standpoint.

Unquestionably, inflation expectations have risen as the market is pricing in higher growth.

The market is not pricing in stagflation (high/rising inflation + zero economic growth or economic contraction).

That's the good news.

But still, the market is spooked by the "risk" that the economy reaccelerates and creates a new wave of inflation, which could necessitate the Fed to actually hike interest rates once again.

Think about it though...

The Fed has cut 100 basis points in the past ~6 months.

If they have to hike 50 bps, then interest rates are back where they were 3 months ago.

I'm particularly focused on 5-year breakevens #T5YIE.

It's currently at 2.46%, meaning that investors want to be compensated at this rate per year to offset the inflation that they think is down the pipeline.

It's trading at the same level as it was on:

• April 2024

• October 2023

• March 2023

• September 2022

• August 2021

• April 2021

In other words, inflation expectations aren't elevated.

At least not relative to where they've been over the past ~4 years.

In fact, inflation expectations are in a 3-year downtrend since peaking in March 2022. They haven't even made higher highs (yet).

Maybe the make higher highs soon, and that would be important information, but they haven't done so yet.

At the present moment, especially because I'm not a Keynesian, I am not of the belief that inflation is going to meaningfully & sustainably reaccelerate.

I don't believe in the "2nd wave" theory.

The comps to the 1970's are irresponsible, at least for now, because the 2nd wave in the mid-70's was caused by an oil supply shock.

Absent that wave, it's very possible (if not, likely) that a 2nd wave of inflation wouldn't have happened.

So what's the takeaway here?

Watch crude oil prices.

Watch XLE relative to SPY.

Watch inflation expectations.

Watch 3M Treasury yields for Fed policy.

Recognize that downside weakness can persist for a bit more, as is common during bull market correction phases, but also recognize that the fundamental "story" that has driven this bull market is likely still intact.

Then just let the market dance for a bit.

Being patient is a form of being defensive.

Cheers fam.

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