Quite simply, this is not the time to be long cyclical risk assets. These include assets which are normally bought during periods which the financial media term “risk on” – stocks (especially high beta ones), Emerging Market (EM) currencies, and high yield corporate bonds, to give a few examples.

As we have stated in our weekly Macro and ETF Edge reports over the past few months, more and more markets have aligned to indicate that a global downturn is just around the corner. 

It started with broad USD strength, which has been going on for about a year now, then moved to affect the US yield curve, which inverted briefly in April this year.

Since then, we have had base metals, copper, aluminum, and iron ore trend lower.

Copper has collapsed over the past month after breaking below its approximately year long range, and aluminum is down more than 40% since making its highs in March.

On top of this, oil prices are back to their pre-Russian invasion levels, even with global oil supply still disrupted by sanctions and war.

Markets are clearly indicating that inflation is due to come down, if not tumble, even though CPI readings are still coming in red hot.

Stagflation is no longer the greatest concern here, deflation is.

This is further confirmed by the US fixed income market, where US breakevens have crashed back to their Omicron-scare levels at the beginning of the year, and the US yield curve has inverted again, this time to a greater degree, and across multiple points.

Charts for all of these markets can be found in Macro Edge #46.

If you would like to learn more about why these specific markets are so important, and how to use them as indicators of the global macro future, check out our course on how to trade global macro.

Given all this, how should you position your portfolio? 

Firstly, you need to decide how aggressive you want to be in relation to the current macro situation.

If you are a more conservative trader/investor, then what you need to do is look at either exiting or hedging your positions. By extension, this also means that if you are looking to pick a bottom in equities and think their sell off is over, you might want to reconsider your position.

Should you prefer to hedge rather than sell out of your longs, you can do so in a variety of ways. Purchasing put options on the SPY ETF will hedge your exposure to broad market risk. Of course, you could simply short the SPY instead of using options.

If your holdings are more concentrated, you can hedge by going short (or buying puts) on a relevant sector ETF. 

Alternatively, going long the USD and/or USTs also serves as a broad portfolio hedge. USTs would be more accessible to retail traders as they can simply purchase the TLT ETF, while going long the USD via ETFs is trickier. 

The best way to hedge using the Dollar is by using a representative basket of currencies, and not the most commonly talked about Dollar Index (DX). As such, if you were to use a Dollar Index ETF, the effectiveness of the hedge would depend on which Dollar Index the ETF actually tracks.

Of course, if you are familiar with trading FX, you can simply go long the USD against a variety of different currencies.

Now, if you want to be more aggressive and see upcoming macro weakness as an opportunity to profit, the trades remain the same, but with slight tweaks:

1. Go long the USD, against EM currencies if you want a higher risk/reward profile
2. Short commodities, namely oil and the base metals
3. Go long USTs, specifically those with higher duration and convexity like the 10y and 30y
4. Short equities, high beta ones like tech and small caps will give a more aggressive risk/reward profile

All four of these trades generally work well in an environment where macro conditions are rapidly deteriorating. If you would like to learn more about why these trades work, and how to maximize your profit on them, our course on how to make money trading a crisis will interest you.

Whatever you choose to do, remember to follow your trading plan!