Forbes AI Newsletter – July 9th

TLDR:

• Fed minutes reveal danger that current high rates of inflation could become “entrenched”
• Steps taken by the Fed to cut inflation could put greater pressure on the economy, with consumer confidence currently trending downwards
• Conflicting forces are causing levels of volatility in the bond markets which haven’t been experienced seen since the early days of the pandemic
• Top weekly and monthly trades

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Major events that could affect your portfolio

Inflation continues to be a major story, with prices showing no signs of slowing despite the Fed making bold moves on interest rates. The minutes from their most recent meeting have been released, and they include some interesting commentary.

They noted that the inflation situation had deteriorated since May, and that if decisive steps weren’t taken, inflation was in danger of becoming ‘entrenched.’ That’s a major departure from previous comments by the Fed and many other major global central banks, who were confident that inflation was ‘transitory’ and would resolve itself swiftly.

With the 0.75 percentage point increase catching headlines, there is now an expectation that we could see a similar rate hike at the next meeting in late July and potentially again in September.

There are some early signs that the policy may be working, with oil and gas prices trending downwards, activity in the manufacturing sector growing at its slowest pace since June 2020 and consumer confidence falling,

This all sounds like pretty bad news for the broader economy and unfortunately, it might be. That said, the Fed is unlikely to be able to bring inflation down without also suppressing overall economic growth. At the moment they appear to have decided that taking the heat out of the headline inflation number is the priority, with lower economic growth the lesser of two evils.

While we’re realistic about the growth potential over the coming 12 months, we’re also of the opinion that the pessimistic sentiment dominating markets at the moment may be overblown.

Why is this important?

For investors looking to achieve greater returns than cash without the volatility of the stock market, the go-to choice tends to be the bond market. Returns haven’t been amazing in this era of low interest rates, but they can generally be relied upon to chug along and cause minimal headaches for investors.

Not lately though.

There’s a major tug-of-war going on in the bond market, with conflicting forces swinging yields wildy. Bank of America’sBAC
MOVE index, which tracks volatility in the bond market, is at its highest level since the early days of the pandemic in 2020.

On one side of the equation is the Fed’s tightening monetary policy, which is pushing yields higher. On the other side is the risk of recession, which puts downward pressure on yields as investors pile out of the even more volatile stock market and into the relative safety of Treasuries.

The Treasury 2-year yield is currently at 3.03%, compared to the 10-year yield of 3.01%. Usually investors would expect to receive higher levels of interest for longer dated bonds, so this inversion of the yield curve is often a sign that recession is on the cards and interest rates are likely to come down. Of course, we know it’s not that simple at the moment, with inflation still a major problem.

The takeaway? The bond market is messy right now, and in the short term it’s likely to remain volatile.

This week’s top theme from Q.ai

Whenever an area of the financial markets isn’t sticking to the script, there’s often an opportunity to take advantage. We’ve been noticing mispricing within the bond market for a while. U.S. Treasuries are often referred to as “risk free” in investment circles, as they’re generally considered the safest asset class to invest in.

Any other investment, including other bonds, will have a risk premium, which is the increase in return investors require in order to compensate them for taking a higher level of risk than they would with U.S. Treasuries.

With all of the economic uncertainty around, yields on corporate bonds have gone up because investors are nervous about the safety of these investments. This is despite the fact that they’re generally from large, stable companies in good financial health.

This means the gap between yields on corporate debt and U.S. Treasuries has become pretty wide, and we think it’s likely to narrow once economic sentiment starts to improve. According to S&P Capital IQ, 10-year U.S. Treasuries are yielding 3.01%, while 10-year U.S. Investment Grade Corporate Bonds are averaging a yield of 4.73%.

This “bond spread” creates an opportunity for investors. It won’t be around forever, but right now it represents a potential mispricing which can be taken advantage of. At Q.ai, we’re constantly on the lookout for themes and trends like this, and we use AI to balance the risk/reward trade off on a regular basis.

Top trade ideas

Here are some of the best ideas our AI systems are recommending for the next week and month.

PROG Holdings Inc (PRG) – The subprime credit lender is on our Top Buys for next week with an A in our proprietary Quality Value factor and EPS growth of 8.43% over the past 12 months.

Alpine Immune Sciences (ALPN) – The biopharmaceutical company is a Top Short for next week and scored Ds in our Technical and Momentum Volatility and Quality Value factors. The company had losses of over $30 million in the 12 months to the end of May.

Mastercraft Boat Holdings (MCFT) – Recreational boat manufacturer Mastercraft is a Top Buy for next month with an A in Quality Value and a B in Technicals and Growth. It currently trades at 4.35x forward P/E.

Evoke Pharma (EVOK) – The gastrointestinal specialist pharma company is a Top Short for next month with D’s in Technicals and Momentum Volatility. It had an LTM EPS of -$2.98 to the end of March 2022.

Our AI’s Top ETF trade for the next month is to invest in automotive, technology stocks and large-cap growth while shorting fixed interest. Top Buys are ARK Autonomous Technology & Robotics ETF (ARKQ), SPDR S&P Transportation ETF (XTN) and Schwab Large-Cap Growth ETF (SCHG). Top Shorts are iShares 1-3 Year Treasury Bond ETF (SHY) and Vanguard Total Bond Market ETF (BND).

Recently published Qbits

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