Robert Martorana's  Instablog

As Dr. Leeb articulated so well today, emerging markets are displacing the U.S. as the engine of global commodity prices. The U.S., meanwhile, has a long way to go to clean up its debt-laden economy. In the short run, this is deflationary, since deleveraging by banks and by consumers is offsetting cheap money from the Fed. This is leading to slow GDP growth, falling home prices, and stubbornly high unemployment.

But massive fiscal and monetary stimuli mean that inflation relief won't last, and will also lead to a weaker U.S, dollar. Investors can protect their portfolios from these outcomes with the nine ETFs noted at the bottom of this article. I am watching them for signals about inflation and the economy, and I have an eye on both trading and long-term portfolio protection. As for me, I am overweight cash, underweight stocks, and long gold and TIPS.


TIPS Are Sole Winner This Week
The only bets that have been working over the last week are TIPS and WIPS. (These are inflation-protected bonds in the U.S. and abroad.) Since August 12, TIP is up 0.6% while WIP is flat. These investments have consistently acted defensively against inflation, while other inflation-hedging vehicles have not.


Dollar Defies Gravity
The DBN is a bearish bet on the U.S. dollar, and it is off only slightly this week. The dollar continues to hold up well despite massive fiscal deficits and cheap money from the Fed. These are stoking concerns about the long-term decline of the greenback, but it is too soon to ride this train. Why? The Fed has defended Treasurys with remarkable vigor, and I believe that they will pull out all stops to defend the dollar. It won't succeed in the long-run, but it is dangerous to fight the Fed these days (as I note below, in my discussion of bonds).


Commodities Are Riding the Market
The major stock market indices are off 2%-3% during the last four trading days, and commodities are down even more. Oil (as represented by USO) and basic materials (IYM) are both off 4.9%, about twice the decline of stocks. Although I believe that oil and commodities are a good long-term hedge against inflation, in the short run they trade with stocks. Likewise for precious metals, which are down  a more modest 1% to 3%.

Why are commodities mirroring stocks? We are in a liquidity boom that is creating the Mother of All Asset Bubbles, and which tends to push correlations together for all risk assets. The global reflation rally is concentrated in commodites, since these are the clearest beneficiaries of rising global GDP. That's one of the reasons that I've noted that gold isn't tracking inflation as well as oil and TIPs. In fact, gold is not trading on inflation/reflation lately; instead, investors are looking to gold as a hedge against financial catashtrophe.


Bonds: Too Soon to Go Short
As David Fry noted today, it's hard to fade bonds, even though this seems like a logical trade. This is because the Fed is supporting Treasury auctions through quantitative easing. This is inflating the bid/cover ratio, so Fed purchases are making these auctions a "success" in the eyes of many market observers. Kudos go to Zero Hedge for highlighting this issue repeatedly.
Therefore, even though I'd like to short bonds by purchasing TBT, there's no sense fighting the Fed. The TBT is down 6.4% since last Wednesday, making it the worst performer in my inflation basket. It's too early for this trade, and being early is the same as being wrong.  (Though being early seems to be intellectually satisfying for certain value investors.)

Defensive Stocks Make Sense, Too
I am underweight stocks because I believe that investors are overlooking bearish signals from second quarter earnings. The reflation rally has been lifting all boats, especially assets with high risk, stocks with high betas, and companies with high operating leverage. The market is ahead of itself, so it's time to be defensive.

In fact, defensive stocks with pricing power make sense during a reflationary/inflationary period. Warren Buffet has mentioned this as an inflation hedge, especially if dividend yields are attractive.

Last week I highlighted five stocks in two defensive sectors, Healthcare and Tobacco. All four stocks are favorably rated by Zacks for strong trends in earnings revisions. The stocks are Amgen (AMGN), Intuitive Surgical (ISRG), McKesson (MCK), Reynolds America (RAI), and Altria (MO).  Altria was downgraded on the day I published the article, so that brings us to four stocks.

Not surprisingly, the two high beta stocks did the worst over the last week, with AMGN and ISRG down 4% each. The tobacco stocks were down less than 1%, and MCK was up 0.4%. McKesson and its peers in medical information are holding up well:  Perhaps as investors are finally putting a premium on defensive growth during the latest market pullback.

Symbol	Name	Price  8/17	Gain/Loss since 8/12
GLD	Gold	91.61	- 1.44%
DBP	Precious Metals	32.08	- 2.02%
TIP	Treasury Inflation Protected Securities	100.90	+ 0.58%
WIP	Int'l Inflation Protected Bonds	54.00	--
TBT	2x Short 20-yr+ U.S. Bonds	48.85	-6.42%
USO	Oil : WTI Cash	35.52	-4.90%
DBC	Commodity Basket: Egy, Metals, Ag	22.36	-2.99%
IYM	Basic Materials	48.63	-4.85%
UDN	Dollar Bearish Index	27.06	- 0.59%
SPY	S&P 500	98.31	-2.47%
QQQQ	Nasdaq	38.48	-3.49%
DIA	Dow Jones Industial Index	91.611	-2.30%

Disclosure: Long SPY, GLD, TIP