Trump takes over? Remember to keep an eye on the re-inflation risk

About this time last year, the market was filled with the anticipation that the Federal Reserve would officially enter a rate-cutting cycle, but the sharp rebound in U.S. inflation in the first quarter of the year doused that enthusiasm.

Now, as we enter a new year, we must be cautious of a rebound in prices. Why do I say this?

1. The Timing of PMI Recovery is a Bit "Mysterious"

In the first week of January, the main macroeconomic data released for the U.S. was the manufacturing PMI index for December. The U.S. manufacturing PMI rose nearly one percentage point from November to 49.3, seemingly on the verge of returning to the expansion zone. The core indicator, new manufacturing orders, surged to 52.5, serving as the biggest boost.

After being compressed for 7-8 months, the manufacturing PMI finally shows signs of a sustained recovery, indeed confirming that the U.S. economy is performing quite well.

However, a key point to focus on is the timing of the manufacturing PMI recovery: 1) Consumer spending on goods, especially durable goods, continues to rise; 2) After a continuous deflation in goods prices (negative or zero growth month-on-month), November saw a 0.3% month-on-month positive growth, suggesting that goods deflation may have ended.

The first half of the U.S. disinflation was mainly achieved through sustained and stable goods deflation. At the end of goods deflation, the rise in manufacturing PMI and the expansion of the manufacturing price index easily raise suspicions about whether the upcoming disinflation narrative will shift from being beneficial for disinflation to being detrimental, causing inflation to continue to decline.

If both goods and services inflation stabilize at a month-on-month growth of 0.3%, this translates to an annualized year-on-year growth of 3.66% for core CPI (and 3.7% is indeed the annualized value of core CPI over the past three months), then the Federal Reserve's guidance of a hawkish interest rate range of 3.75%-4% for 2025 is indeed within a reasonable range.

With only 50 basis points of rate-cutting space available in 2025, it is crucial for Federal Reserve Chairman Jerome Powell to make good use of his limited ammunition—on one hand, he needs to observe the implementation pace of Trump's policies, and on the other hand, he must leave some room for maneuvering with the Trump administration.

In addition to the potential for a resurgence of goods inflation due to the recovery of PMI itself, other policy expectations related to Trump (the presidential transition on January 20) — whether it be the expulsion of immigrants, which may deter companies from laying off workers to avoid future hiring difficulties, or raising tariffs, which may lead some companies to import and stockpile goods in advance, thereby increasing demand for goods — do not help alleviate inflation in the first quarter These factors combined basically mean that the timing for a remaining 50 basis points rate cut in 2025 will become very uncertain, and the probability of a rate cut in the first quarter will significantly decrease.

Dolphin believes that sustained high interest rates are not favorable for the stock market, especially under significant pressure from external markets. Meanwhile, in the U.S. economy, the credit card default rate among the poor is rising, which will also exert considerable pressure on some price-sensitive consumer goods.

II. Where is the market trading?

As Trump is about to return to the White House on January 20, last week's trading was quite interesting:

a. The dollar continued to rise, almost reaching 110;

b. The 10-year U.S. Treasury yield has reached a high of 4.6%;

c. For the same maturity government bonds, the 10-year U.S. Treasury yield is rising, while the 10-year China government bond yield has dropped to around 1.6%, with the yield spread inversion becoming increasingly severe.

Clearly, these indicators together are very unfavorable for external assets, including Chinese assets. In the short term, the domestic policy expectation game has come to a pause, and with the fundamentals unlikely to improve in the short term and external market pressures mounting, Chinese assets can only decline to relieve pressure.

Although high interest rate expectations generally suppress the performance of equity assets in the U.S. stock market, the performance of different asset categories is still not very consistent. High interest rates have suppressed overvalued assets and consumer goods assets, while energy and public utilities have performed relatively well.

Overall, in the short term, Chinese concept assets may continue to be suppressed, while U.S. stock assets, under the pressure of high valuations and high interest rates, have also entered garbage time, and we should be wary of the possibility of a rise in non-farm employment data to be released this week.

III. Portfolio Adjustment and Returns

There was no adjustment to the portfolio last week. The Alpha Dolphin portfolio's return fluctuated at -0.2%, significantly outperforming the CSI 300 (-5.2%), MSCI China (-2.8%), Hang Seng Tech (-3.0%), and S&P 500 (-0.5%).

Since the start of the portfolio testing (March 25, 2022) until last weekend, the absolute return of the portfolio is 66%, with an excess return of 79% compared to MSCI China. In terms of net asset value, Dolphin's initial virtual asset of 100 million USD has exceeded 168 million USD as of last weekend.

IV. Contribution of Individual Stocks to Profit and Loss

Last week, the assets generally experienced a decline, whether in U.S. stocks or in the technology and semiconductor sectors within U.S. stocks. The reason Dolphin's portfolio outperformed is mainly due to the stable performance of its weighted holding, TSMC.

The stocks that fell significantly generally had low weightings; at the same time, the high weighting of cash and cash-like assets helped to some extent avoid the downturn.

V. Asset Allocation Distribution

The Alpha Dolphin virtual portfolio holds a total of 14 individual stocks and equity ETFs, with a standard allocation of 3 stocks and 8 equity assets being under-allocated. The remainder is distributed among gold, U.S. Treasury bonds, and U.S. dollar cash.

As of last weekend, the asset allocation and equity asset weighting of Alpha Dolphin are as follows: