Stagflation Nation, My Cybersecurity Trade, More Fed Games

For the second time this week, really the second time in three days, the major U.S. equity indexes opened close to their highs for the session and sold off from there. On Thursday, it was almost as if any positivity created around the president's tariff exemptions for many chip manufacturers and any good cheer created by what could be seen as progress on fostering a Russian-Ukrainian de-escalation simply wore out.

There was, however, more to it than that. Stocks do not get tired and neither do algorithms. For one, a bevy of Wall Street economists and strategists warned publicly that a stagflationary environment was now a realistic risk after the president's reciprocal tariffs went live on Thursday morning. According to Bloomberg News, troubling calls were made by economic/market types at Bank of New York Mellon, Bank of America, TD Securities, Brown Brothers and Apollo Management.

Apollo Management Chief Economist Torsten Slok wrote, "The market is clearly expecting cuts, but the upside risks to inflation are significant. The bottom line is that the stagflation theme in markets is intensifying.” 

Bank of New York Mellon strategist Geoffrey Yu wrote, “The still-evolving tariff region will prove stagflationary, both lowering growth and raising inflation. This is exactly what appears to be happening now.”

My Take

Am I concerned? Of course, I am. I make my living in these markets and stagflation does not improve conditions for increased economic activity, corporate margins or the U.S. consumer. That said, as I have already publicly addressed this possibility this week, I do see the potential for a period of above-target inflation, I definitely do not see runaway inflation. Inflation closer to 3% than 2% will not wreck the economy and does not feel like 4% or 5% inflation.

Secondly, while I do see a period of compressed corporate margin, especially for muti-national businesses that fail to adapt, I also see a period of potentially explosive economic activity due to reduced taxes, reduced regulation and increased AI-related productivity that kicks in late 2025 into early 2026.

Now, to be clear... I am not a "gummy bears and candy canes" kind of economist. I do see the obvious threat to the demand side of the labor market created through that increased productivity. There will be a limit to this "explosive" period. That does not negate nor diminish the fact that in my opinion, there will be a burst of activity.

If there is a short period of increased consume-level inflation coupled with stalled economic growth, it will not resemble anything close to what we as a nation experienced 50 years ago. To refresh, during that post-Vietnam era, consumer-level inflation peaked above 13%, unemployment peaked at nearly 11% and U.S. GDP averaged negative growth rates over a nearly two-year period. This will not be anything close to that. Remember, these strategists most often cannot have personally managed skin in the game. Their worth (not to mention their year-end bonus) is often measured by their impact and ability to get their employer's clientele to act.

The Bond Raffle...

On Thursday, the U.S. Treasury "raffled" off $25 billion worth of new Thirty Year Long Bonds. The auction went off about as well as one might have expected if I'm writing about it the next morning. After poor Three-Year Note and Ten-Year Note auctions this week, this auction did no better. At a high yield award of 4.813%, the auction tailed the "when issued" by 2.1 basis points, which was the largest tail for this series since August 2024.

Bid to cover, at 2.266, was the lowest for this series since November 2023, as demand clearly suffered. Indirect Bidders (foreign accounts) walked away with 59.8% of the new paper, which was the second-smallest piece of the pie for this group since 2021. Direct Bidders (domestic accounts) took down 23.03% of the issuance, which was below average, but not especially poor. That meant that dealers were stuck with 17.46% of the auction, again the largest percentage of any auction in this series that Dealers were forced to eat since August 2024.

Interesting...

One often thinks that sectors with defensive characteristics perform as a group. This could not be further from the truth. Among the 11 sector SPDR ETFs, the Utilities XLU are the top performer year to date at +15.96%, while Health Care XLV is the only loser at -5.41%. The underperformance is largely due to the beat down suffered across several healthcare related industries.

The Dow Jones U.S. Health Care Providers Index is down 23.69% year to date, led lower by Centene CNC and UnitedHealth Group UNH. The Dow Jones US Pharmaceuticals Index is down 7.84% year to date, led lower by Novo Nordisk NVO and Moderna MRNA and the Dow Jones U.S. Biotech Index is down 2.3% year to date, led lower by Illumina ILMN and Regeneron REGN.

Just an FYI, the Staples XLP are middle of the pack in 2025, in sixth place. Big Tobacco has soared, while Distillers and brewers have been pummeled.

The Fed

Pres. Trump has apparently decided to nominate Council of Economic Advisers Chair Stephen Miran to serve on the Fed's Board of Governors in place of current Gov. Adriana Kugler, who has already announced her resignation. Miran would be a placeholder as Kugler's term expires this January. A permanent replacement will be nominated at a later time. The spot may be used to introduce (or re-introduce) the next Fed Chair to the Board of Governors and Jerome Powell's term at the helm of the central bank expires in May.

Bloomberg News is reporting that current Fed Gov. Christopher Waller has emerged as possibly the favorite to take on the role of Chair at the Federal Reserve Bank in place of Powell. Other candidates are known to be former Fed Gov. Kevin Warsh and current Director of the National Economic Council of the United States Kevin Hassett.

I have long championed Judy Shelton for either the top spot or as a replacement for Kugler and will continue to do so. Shelton is a firm believer in a harder, sounder, somewhat asset-backed, somewhat less fiat in nature currency. As a nominee to the Board of Governors during Pres. Trump's first term, Shelton did not get through the Senate confirmation process due to those beliefs.

Often politicians do not even understand that there are less Keynesian, more Austrian styles out there and more than one method can be effective. Especially if current methods have only increased probabilities for broad, public failure. 

If those interested have not read Shelton's theories for improving the quality of US Treasury debt offerings and subsequently the quality of the U.S. dollar relative to other reserve fiats and have a mind for that sort of deep thinking, those readers are missing out on a real treat.

Trading

Cybersecurity name Fortinet FTNT was taken out to the woodshed (-22%) on Thursday. The problem is that the company is 40% to 50% through an upgrade cycle that is expected to be completed by year's end. Investors felt that the company would have generated more revenue at this stage of that cycle. This pressure took the entire group lower in sympathy, as that's what algorithms representing passive investment strategies do.

As readers know, I am heavily invested in the space. As this issue is likely Fortinet-specific, I added to my long positions in CrowdStrike CRWD, Palo Alto Networks PANW and SentinelOne S on Thursday's weakness.

Overnight...

Taiwan Semiconductor TSM reported a nearly 26% year-over-year increase in July sales largely due to an acceleration in AI-capable chip sales. Taiwan Semi is the primary contract manufacturer for Nvidia NVDA, Advanced Micro Devices AMD and Apple AAPL and the investment in and expansion of Taiwan Semi's facilities in Arizona should keep all those firms out of tariff trouble with the Trump administration.

Economics 

(All Times Eastern)

1:00 p.m. - Baker Hughes Total Rig Count (Weekly): Last 540.

1:00 - Baker Hughes Oil Rig Count (Weekly): Last 410.

The Fed

(All Times Eastern)

No public appearances scheduled.

Today's Earnings Highlights 

(Consensus EPS Expectations)

Before the Open: ESNT (1.71), WEN (.25)

At the time of publication, Guilfoyle was long CRWD, PANW, S, NVDA, AMD equity.