Inflation is going higher, this market strategist says. Here's his master ETF plan to profit from it.

MW Inflation is going higher, this market strategist says. Here's his master ETF plan to profit from it.

By Jonathan Burton

Hedgeye's Keith McCullough is long gold, utilities, real estate and emerging markets ETFs

'There's been a bottom for inflation and probably a high for expectations of Fed rate cuts.'

What the Fed gives, the Fed can take away.

Nowadays that means interest-rate cuts. The U.S. Federal Reserve's half-point rate cut in September gave the stock market just what it wanted. Now the market wants more - and expects it.

But the latest U.S. jobs report and other economic indicators have thrown the market's confident "soft-landing" scenario into disarray. There's growing concern among investors that the Fed has not tamed inflation completely. If that's so, then inflation will stay higher for longer - squeezing consumers, elevating bond yields and home mortgage rates, and putting additional Fed rate cuts on hold.

Keith McCullough, the CEO of investment service Hedgeye Risk Management, isn't waiting to see what happens with interest rates and the Fed. His goal is to stay ahead of the U.S. central bank, building portfolio positions in anticipation of where he thinks the markets are heading, and being nimble enough to trade out if his base case doesn't materialize.

"I never fight the Fed; I just try to front run it," McCullough says.

Right now that's led him to advise investors to own assets that do well when inflation reaccelerates. He's long gold, utilities, real estate and emerging markets.

Stocks outside of the U.S. are important to McCullough's portfolio configuration, because there's money to be made in these countries and most investors, being U.S.-centric, miss the opportunity. Emerging markets he's bullish about at the moment - and McCullough is quick to shift positions if he perceives changing conditions - include India, Singapore, Malaysia and South Africa.

In this recent interview, which has been edited for length and clarity, McCullough shared his views on the Fed and inflation, and mapped out a portfolio geared for the challenging investment climate he sees coming. (For more on his approach to investing, McCullough provides detailed tips in a free e-book: "Master The Market: A Hedge Fund Manager's Guide to Process and Profit.")

'Wall Street is trying to tell you that inflation is going down towards 2%. We don't agree. '

MarketWatch: Many investors have positioned their portfolios for lower U.S. interest rates and benign inflation. Not you. What are you seeing that others aren't?

McCullough: There's been a bottom for inflation and probably a high for expectations of additional Fed rate cuts. Hedgeye's main investment theme now is "Quad 3 stagflation" - U.S. inflation is accelerating while real economic growth is decelerating.

Wall Street is trying to tell you that inflation is going down towards 2%. At Hedgeye, we don't agree. Inflation is going back up. It hit its low in the September report and now we think it's going back towards 3%. We'll be at 3.1% by the beginning of next year.

I mean, food prices are up double-digits, and all these things are going right back up because that's what happens when the Federal Reserve signals a devaluation of the U.S. dollar (DX00) and an increase in the money supply.

MarketWatch: Where are you telling clients to put their money so they can ride this wave?

McCullough: We're long gold (GC00), using SPDR Gold Shares ETF GLD, gold miners, through the VanEck Gold Miners ETF GDX, and platinum (PL00), with abrdn Physical Platinum Shares PPLT as the ETF. We've been long on real estate and utilities, using Real Estate Select Sector SPDR Fund XLRE and Utilities Select Sector SPDR XLU as the ETFs.

And yes, prices for these investments have gone up a lot, but I like that. I don't get out of something because I'm making money, provided that the conditional factor on why I'm making money, is still valid.

We've also been adding emerging markets - Singapore with iShares MSCI Singapore ETF EWS, Malaysia, with the iShares MSCI Malaysia ETF EWM, Thailand, through the iShares MSCI Thailand ETF THD. We have also been long India for over a year, using the iShares MSCI India ETF INDA, which has been awesome. India is growing - it shows the fastest GDP growth rate in the G20. This is what's going on in the world. The other country we're long is South Africa through the iShares MSCI South Africa ETF EZA, which has been awesome as well because it has so much gold exposure.

'Get the direction of the U.S. dollar right, and you get a lot of other things right.'

MarketWatch: One of your key indicators is the U.S. dollar. Right now you're bullish on the currency because of your inflation call - higher inflation equates to a stronger dollar. Why should investors care about this?

McCullough: Get the direction of the U.S. dollar right, and you get a lot of other things right. I call it the "DREAM" - the dollar rules everything around me. The dollar accounts for 96% of trade invoices in the Americas, 74% in Asia-Pacific and 79% in the rest of the world. So if the dollar is being devalued, then hard assets reflate. Why do the emerging markets do better in that environment? Many EM countries have significant short-dollar positions.

In Quad 3 stagflation like we're in, you want to be long large-cap versus small cap. We're long energy stocks including Exxon Mobil $(XOM)$ and gold miners including Newmont $(NEM)$. Among the U.S. growth stocks that we like is DraftKings $(DKNG)$, for example. We also like Restoration Hardware $(RH)$ and Nike $(NKE)$, which is another big global growth stock. For energy exposure, we use the Energy Select Sector SPDR ETF XLE - almost 40% of that ETF's portfolio is in Exxon and Chevron $(CVX)$.

Even the "Magnificent Seven" stocks - on an intermediate-term trend duration, all of them other than Tesla $(TSLA)$ and Alphabet $(GOOGL)$ are signaling buy: Apple $(AAPL)$; Microsoft $(MSFT)$; Meta Platforms $(META)$, Netflix $(NFLX)$, and Nvidia $(NVDA)$ are all buys. You can get exposure to them with the Invesco QQQ Trust QQQ ETF or a Magnificent Seven ETF. This is where the money is going - like 90-plus percent of retirement accounts flow into target date funds and they're over-indexed to these stocks.

'The Federal Reserve is devaluing the U.S. dollar.'

MarketWatch: You're also concerned about the dollar's diminishing purchasing power and its impact on Americans and others who get paid in dollars. Why is this important?

McCullough: The much larger picture is that the Federal Reserve is devaluing the U.S. dollar. The dollar has lost 96% of its value from 1913 through 2020. It took the Roman Empire, like, 200 years to debase their currency, the silver denarius, by 95%.The U.S. did that with the dollar in 107 years. That's really bad when you think about the purchasing power of Americans in dollars - but nobody really wants to talk about it that way.

If your response to declining economic conditions and falling markets is to print money, then you bring back the thing that you're trying to kill, which is inflation. The U.S. dollar in the past 25 years alone has been devalued by 78%. The Fed provided a lot of easy money for a lot of people to use leverage on top of that easy money. And people get inflation.

I make money on it, but other people have to pay for it - people like my dad, a retired firefighter. He doesn't own all the things that I own that are inflating. When you go back 25 years, you have both Republicans and Democrats responsible for it. And here we go again, no matter who wins the presidential election.

MarketWatch: You're critical of Wall Street's pervasive 'happy talk' and herd mentality. But let's say your base case on inflation and the Fed is wrong. What's your move then?

McCullough: Wall Street's begging the Fed to keep cutting rates and the Fed seems to be cuddling up to the expectation that we're at the beginning of a rate-cutting cycle. So we really need to see the data break the back of that narrative and of that consensus. And then I have a lot of decisions to make.

I'm not going to stay long everything I'm currently long if the Fed decides to stop cutting rates and raises them - which, if the Fed was being data-dependent, is exactly what they would be doing. Instead, I'll do what the Fed is actually doing; I won't fight that. People say, "Don't fight the Fed." I never fight the Fed; I just try to front-run it.

More: The stock market is ready for its melt-up as investors ignore growing risks

Also read: Stocks and gold are both at record highs. Only one will be right on inflation.

-Jonathan Burton

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November 02, 2024 12:16 ET (16:16 GMT)

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