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The Fed Is Finally Honest About Inflation — Just as It Starts Slowing

by | Dec 1, 2021

My favorite quote from Federal Reserve Chair Jerome Powell’s testimony Tuesday had me chuckling all morning Wednesday…

Pennsylvania Sen. Pat Toomey asked him, “How long does inflation have to run above your target before the Fed decides, maybe it’s not so transitory?”

And Powell replied, “I think it’s… it’s probably a good time to retire that word and try to explain more clearly what we mean.”

Gee, thanks, Jay… it’s only taken you 18 months.

The irony here is that judging from Wednesday morning’s Institute of Supply Management data release, inflationary pressures are slowing! So since it’s free trade day, we need to discuss how to trade slowing inflation this December.

Source: Bloomberg

ISM Prices Paid came in nearly 4% lower than the prior month, retreating from its post-delta-variant reopening peak in October. Levels now sit more than 10% off of cycle highs back in June.

And with the CDC announcing the first U.S. case of the omicron variant, it is possible a government freakout could slow inflation even further in December 2021.

Source: Bloomberg

On the other hand, ISM Manufacturing and New Orders both came in slightly higher, indicating that although inflation may be slowing, the economy is still chugging along.

For now, anyway…

How to Trade Slowing Inflation in December 2021

I should note that Oil and other energy-related commodities — such as natural gas and coal — don’t backtest well as materials under those conditions…

Source: Fortune Research

So we have to keep a close eye on both the United States Natural Gas Fund (NYSEArca: UNG) and CONSOL Energy Inc. (NYSE: CEIX).

To that end, natural gas prices are breaking down toward summer support levels. 

Source: Bloomberg

And while I still hold a bullish bias through winter, December temperatures in the U.S. look mild so far through the holidays.

Source: NOAA

That’s why I said in both Monday’s free trade alert and Tuesday’s watchlist alert to “keep sizing small and keep plenty of dry powder handy.”

If gas does meaningfully break down below $4.20/mmbtu, then we need to at least take the foot off the accelerator — if not hit the brakes. If that happens, we’ll simply watch prices and wait to add some a little lower.

Remember, this isn’t a long-term play. The exit strategy here is to close out everything during the first big winter storm… and never look back.

Despite the wild swing lower in CEIX, domestic thermal coal prices still haven’t budged.

Source: NOAA

Unfortunately, that coal isn’t traded on a public exchange. As a result, almost nobody knows that’s the case, and shares may just bounce around with broader energy sector sentiment.

Those high prices mean I’m still optimistic they’ll crush earnings in February. But a meaningful dip down below the $21 mark, and we may have to cut exposure and jump back in at a lower level toward the end of the year.

So I want to pivot completely away from the sector for this. When it comes to how to trade slowing inflation in December 2021, let’s add in the ETF with the highest expected return for strong growth and slowing inflation.

The Materials Select Sector SPDR ETF (NYSEArca: XLB) has a number of holdings that remain either short on supply, or will benefit from the recently signed infrastructure bill.

Source: Marketwatch

The top companies among its holdings are all growing solidly, while exposure to industrial gases, paint, copper, steel, gold, chemicals and lithium provide a diversified hedge against inflation.

With the omicron variant dominating headlines, we need to take it slow. So again, keep sizing small and plenty of dry powder handy.

I’ll be back Thursday to take a closer look at these companies.

Until then, stay frosty folks… This market is choppy as hell and unchained from fundamentals.

All the best,

Matt Warder

Fortune Research

WRITTEN BY<br>Matt Warder

Matt Warder

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