Two Paths

Inflation expectations can vary significantly depending on who is doing the talking. Republicans and Democrats are apparently hearing very different voices on this topic. That will soon matter to investors, given the range of reaction functions possible in markets. So, which is it?

The University of Michigan survey of inflation expectations (below) is striking. The difference between political party inflation outlooks couldn't be more divergent. I'm pretty sure the independent variable at work is the 'news source'. Trump-loving talking heads at FOX have convinced viewers that Despot Donny's policy mix will bring down the price of everything from eggs to energy. MSNBC-listening Democrats only hear about the colossal price hikes that tariff policies bring. These duelling echo chambers seldom agree on anything. Surprisingly, I'm leaning toward the GOP-Fox on this one, but not for the reasons they are serving up.

University of Michigan Inflation Survey

Inflation prospects are improving not because of Trump's plans but despite them.

I believe trade tariffs lower growth, misallocate resources and create lower long-term inflation - full stop. And markets agree with that statement. Bond yields have moved lower. Emerging markets, ex-China, are moribund. The Indian market, about which I was so optimistic, has fallen to new correction lows. Back home in Canada, despite gold shares putting on a brave face, banks and energy stocks have rolled over. Sentiment is slumping everywhere. Investment plans have been shelved worldwide.

Small caps and value stocks have also paused in the US market after the Trump euphoria balloon was popped by tariff worries. And even within Mag7 growth stocks, there has been bifurcation as Tesla collapsed from a wave of Musk-off selling, and Apple slowly rots under a China death threat.

The bull flattening of the US Treasury curve indicates Trump's simultaneous meddling in trade and government structure. Despite the arbitrary and brutal cuts to civil service, the prospect of a reduction in discretionary spending has calmed bond market vigilantes for now, thus lowering the long bond yield. Meanwhile, short-term inflationary impacts of tariffs and growing wage pressures keep the Fed on hold in the short term, further retarding growth.

Signalling from the bond market has been muffled by the Treasury's decision not to extend term by issuing fewer than expected longer-dated securities. Following Janet Yellen's policy ploy, Treasury Secretary Scott Bessant has quickly picked up on this party trick, squeezing the bond bears into covering. But the message is clear: stocks have peaked, and bonds are bid.

So where is the sell-off? Nowhere to be found! Stock volatility has paradoxically dropped just as headline risks have soared. That means this choppy, idiosyncratic, specific risk-driven environment should persist for a few more weeks. Earnings have been strong, and the economy is still growing above potential. The promised tax cuts and deregulation benefits are still ahead. This Goldilocks environment is a trader's dream but a macro investor's nightmare - hence the bags under my eyes.

So, the path forward looms large. Tariffs vs deregulation. Fiscal austerity vs tax cuts. Disinflation vs accelerating inflation. You must choose your own.

And that will make all the difference.

Risk Model: 4/5 - Risk On

With the hoarding of copper in advance of tariffs, there could be a head fake in the copper-gold ratio here. However, it could also be the start of an improving environment for cyclical stocks that may create a durable rotation. For that, we would need to see a quick resolution in the tariff war and a refocussing on pro-growth policies from governments and Central Banks. The jury is still out for the markets, just as it is for the Mango Messiah.

Copper/Gold

As for sentiment, an AI bubble hangover (similar to that experienced yesterday morning by Super Bowl fans) has investors reaching for Tylenol. Financial media stories now are about what could go wrong with AI business models - not what could go right. DeepSeek and ye shall find - worries!

Either way, it seems the teams are in the locker room resting up for the second half. But judging from the subdued VIX and lack of outflows, investors seem more worried than panicked. It may be risky to be complacent if Trump bites more than barks. The 'Trump Put' exercise price may be far lower than here. Keep some dry powder for now.

AAII Bull/Bear