“Anything simple always interests me.” - David Hockney
I have noted before that the question of whether one should be “risk-on” or “risk-off” can largely be answered by whether inflation expectations are rising (good for stocks, bad for bonds) or falling (good for bonds, bad for stocks). The key word here is expectations. I noted in an article I wrote published by Marc Faber of the Gloom Boom and Doom Report that the markets were warning of a coming deflation pulse as early as February. In many ways, this was the genesis of the Summer Crash call first written here on SeekingAlpha.
One way of seeing if inflation expectations are returning is by looking at the price ratio of the Treasury Inflation Protected Bond ETF (TIP) relative to nominal 7-10 Year Treasuries (IEF). As a reminder, a rising price ratio means the numerator/TIP is outperforming (up more/down less) the denominator/IEF.
(Click chart to expand)
Think of an uptrend in the ratio as a bet on inflation, and a downtrend as a bet on deflation. Very simply, the persistence of outperformance can be seen as an indicator of whether the environment favors risk taking or not in equities (IWM/DIA). The trend appears to be just getting started after collapsing in July and August. Should a new uptrend emerge here, as I suspect it will, it further argues the idea that a Fall Melt-Up is in its early stages and a very real possibility.
Disclosure: The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
