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The Other Side of A Pair of Uncomfortable Trades


The pairings in the stock market that make you most nauseous are awfully correlated with good trades nearby.


Bushel of Inflation

So it turns out there is a little inflation after all, shocking no one but hedonistically adjusted shut-ins. I will let economists point to the problems. I would rather find a few of the opportunities among the feedstocks fueling those concerns. Below you'll find a chart of Wheat, Corn, and Soybeans. Ladies and gentlemen, these are their moves in the past four weeks alone, slipping through the teeth of slowdown fears.

Click here to enlarge.

While most eyes are on U.S. inflation numbers, I'd point instead to China's inflation rate which not so quietly rose to 10-year highs this week. China was a wheat exporter until recently when it had to stop, and instead take reserves from its own stockpiles to feed itself. The USDA has projected that U.S. wheat supply threatened to reach its lowest level in 59 years and further trimmed its worldwide supply estimate.


To put meat between those slices of bread for the first time requires there be enough corn and soy meal to feed the cattle and pigs. This extremely tight balance is being severely overlooked by alternative energy supporters burning fields of food for questionable fuel. We have all been reminded recently that we better be careful what we ask for. Sadly, hundreds of millions of people are not asking for fuel: They are begging for food.

Very little has changed in my book among my longest longs busheled around my firm's "Food that Feeds Food" trade – the tight supply of crops needed to support swelling demand from millions of capitalists sitting down for some of their first square meals.

There will be severe pullbacks and doubts along the way but the math is quite simple. World population is expected to grow from 6 billion to 9 billion over the next four decades while farming soil to feed them declines from two-thirds of an acre per capita to less than half an acre.

Too Full?

I wonder if two trades might be on the other side of this hunger, sprawled out with bellies and brokers full of profits, yet quite exposed to these soaring input costs for the manufacturers who have to turn raw materials into dividends and meals. Two sectors have moved relentlessly higher, owing much of their moves to rotation into their seemingly defensive makeup: Utilities (XLU) and Consumer Staples (XLP). Each has begun to look vulnerable to me after extending rallies as far as two standard deviations above their 50-day moving averages recently.

Pulling the covers back on the Utilities, you'll find more than 90% of the stocks are above their 50-day. With no inflation to worry about and rates moving down, it has made good sense to buy Treasury bonds and even more sense to buy higher yielding competitors for 'safe' money, like Utilities. At this point, using my firm's own data instead of the sedentary hedonist's, it does not make as much sense. And if rates are heading higher some investors will be surprised to see how quickly the safe money turns into quick sellers.

Making even more sense during the embalming process of each of your neighbors prior to the latest scheduled funeral for the U.S. consumer was to load up on canned meat and head to the Proctor & Gamble (PG) decorated bunker before the adjustable-rate-bogeyman came knocking on your door too. Consumer Staples have been bought in size and there is not an analyst or strategist I have found who does not love the way they are set up in here.

If some of the staples (think food and drink companies) are getting squeezed by soaring input costs it makes some of the rallies even more questionable. These stocks are viewed as a safe haven and owe much of their moves to fears of a slowdown in discretionary spending where capital has violently flown away from. I am scanning the menu for the opposite pair, instead…

Pair with Nausea

Yes, that's spam sushi. Pairing Consumer Discretionary longs with Consumer Staple shorts may actually make this Spamaurai, patent pending, look good by comparison. But I've found the pairings in the stock market that make you most nauseous are awfully correlated with good trades nearby. And to be clear, I am working carefully inside each with only a handful of selections, not making entire sector calls here.

To illustrate the extreme ramp in Consumer Staples and breakdown of Consumer Discretion I will use four stocks I can be objective about since I do not own the stocks or buy from any of them. The latter fact making the Special K, my wife, entirely grateful and disgusted, respectively – a pair I've had on for much longer: Hormel (HRL) and Coke (KO) against Nordstrom (JWN) and Coach (COH).

Click here to enlarge.

This menu makes no sense at all if I was following much of the bad news we've been receiving in a straight line. I have yet to see too many straight lines for too long. My firm carefully measures each sector for extreme deviations and we are near two of them. My firm's indicators for overbought and oversold are merely clues and footprints where we start tracking down secrets kept inside each.

From my perch each of these sectors' moves has been too convinced of where we're headed next. I am not convinced. My firm's system is actually built on the opposite – flexibility and curiosity – and relies on being wrong quite often to know we're receiving disproportionate odds when we're right. And then we cheat, putting stops underneath, to tilt the math in our favor. My trading diary is clearest on one thing and favorable entry points are often born on the other side of conviction.
No positions in stocks mentioned.
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