The so-called “Trump trade,” which reflects the expectation for inflation, has been losing steam in the market.
And now former global macro fund manager Raoul Pal sees a big contrarian opportunity. Going against the crowd, Pal is recommending that investors buy bonds. Specifically, he recommends U.S. 10-year Treasury notes (^TNX).
Pal made the recommendation earlier this month in his exclusive research letter, The Global Macro Investor, which is read by the hedge fund elite. Late Monday evening, he shared his thesis publicly in a 14-minute video on Real Vision Television, a subscription investing video service he co-founded.
“I think the main thing we need to look at is the narrative out there and I often talk about narratives in videos,” Pal said in the video. “The narrative right now is reflation — ‘inflation is coming back.’ You see it all over Twitter. If you search for terms in Google, you see ‘inflation, inflation, inflation.’
“But I always like to look behind the headlines and figure out what’s going on,” he added.
Why the inflation numbers look high
Pal honed in on the year-on-year change on some economic indicators. He observed that indicators, such as Consumer Price Index (CPI), are at elevated levels today due to moves in late 2015, early 2016. This was when we saw big downward moves in equities, oil, and commodities.
“All of these things had translation effects,” he said. “So, they brought down a lot of economic indicators. And the economy was slow at that time as well.”
Compared to a year ago, it looks like there’s been a huge rise in prices because everything had fallen so much the previous year. Inflation, for instance, fell dramatically last year because of the collapse in commodity prices, particularly oil prices.
“The big driver of CPI, or headline inflation, is, in fact, oil prices,” Pal said. “Oil prices is the key thing that moves the CPI up and down, which is why we often look at core CPI, or CPI ex-energy. But the headline CPI that the markets are looking at and focused on right now is, in fact, CPI that’s taken into account the price of oil.”
He continued: “So if we look at the year-on-year rate of change of oil — again, remember we are comparing low oil prices from last year when it hit down to $30 a barrel. And where it is now, which is around $50 a barrel, the rate of change is huge… If you remember this point last year March, April, May, June, the oil price started picking up, so that would mean the year-on-year rate of change of oil is going to start dropping dramatically.”
He’s calling for CPI to peak out “right about now.” He sees CPI “rapidly” falling from current levels to 1%.
It’s not just inflation data, though. Pal thinks economic data, such as the Institute of Supply Management’s (ISM) manufacturing index, is going to start weakening.
Positioning is lop-sided
Recently, data on speculative positioning revealed that the size of the short position against bonds, which means investors are betting that yields will explode higher, has never been larger.
Pal, however, sees bond yields moving sharply lower. When bond yields fall, prices rise.
“Now, I’ve been around the block a long time, and I’ve seen this in Japan so many times before,” he said. “What I’ve noticed is that people want to extrapolate inflation. That was the 70s, right?”
“I’m looking for the reversal in inflation, he said. “I can see it coming. I know the speculators are record short bonds, so that gives me an advantage where I think the probability is that everyone is going to be on the wrong side of the boat at the wrong time.”
Watch the full video at Real Vision.
Julia La Roche is a finance reporter at Yahoo Finance.