Market menace or trade opportunity?

With earnings season winding down and China (for the moment) on the back burner, many investors are worrying about a rising interest rate environment weighing on the stock market, especially since the Federal Reserve’s favorite price gauge—the Personal Income Expenditures (PCE) price index—last week showed US inflation had approached the Fed’s 2% target level.

And wouldn’t you know it, the Producer Price Index (PPI) comes out today, followed tomorrow by the Consumer Price Index (CPI).

For some important context: Inflation reaching 2% doesn’t automatically mean runaway prices and a crumbling stock market. Second, shorter timeframes can offer at least partial immunity to inflation, because the catalysts that drive short-term market moves—earnings, economic news, geopolitical events, mergers, and so on—won’t cease to exist if inflation becomes the dominant macro theme in the market.

Further, there are a ton of possibilities out there that many traders employ to attempt to benefit from this type of environment, so let’s walk through a few fan favorites.

First, of course, broadly speaking traders also have the flexibility to take short positions (either in the broad market or individual stocks) if they anticipate down moves.

And then there’s gold, which has long been considered an inflation hedge—although the data suggest its performance in this regard is mixed, at best. In fact, with the exception of the 1970s—when double-digit inflation rocked the US economy and gold took off to the upside—there hasn’t been much evidence that gold increases in value when inflation is on the rise.1 In other words, outside of a 1970s-like “inflation shock,” gold bulls could be disappointed by the metal’s upside, even if inflation continues to rise.

June gold futures (GCM8), 5/9/2017 – 5/8/18. June 2018 gold futures price chart.

Source: OptionsHouse

Gold’s recent performance (June gold futures dropped to their lowest levels of the year last week) suggests the market may not be concerned about imminently-high inflation, or it simply isn’t going to react to inflation (or inflation worries) the way some people may expect.

Next up: Financials. Bank stocks are sometimes cited as favorable long-side plays in a rising-rate environment because one of their primary revenue sources comes from lending capital at interest—and the higher the rate, the more they profit (see “Trading the inflation card”).

Some financial exchanges may also fit the inflation-fighting bill. For example, the CME Group (CME) has been cited as a possible inflation-resistant stock because of its potential to benefit from increased financial hedging against rising rates—both through its many interest rate instruments, as well as in stock index and currency futures and options.2 More trading volume, more profit.

That’s a long-term perspective, so the ostensible approach would be for long-oriented traders to buy such stocks on weakness. The following daily chart shows CME has possibly begun forming a trading range after reaching a record high near $172 in March:

CME Group (CME), 8/24/17 – 5/8/18. CME daily price chart. Tested the low.

Source: OptionsHouse

CME shares, which are up around 50% over the past year, recently tested their April swing low around $155 (which falls within a longer-term support/resistance zone), trading to lower intraday lows but rallying strongly last Friday. Bullish traders, certainly, will be looking for the stock to hold that level.

In the end, unlike investors, traders should probably be less concerned with the prospect of higher inflation, and more interested the possibilities it presents.

Market Mover Update: Oil and gas producer Devon Energy (DVN) has pulled back after last week’s earnings-announcement jump (see “Options smoke points to price-action fire”), and yesterday traded back into its pre-breakout consolidation—similar to the way the stock behaved after its mid-April up move:

Devon Energy (CME), 1/5/18 – 5/8/18. Devon Energy (DVN) daily price chart. Pattern repeat?

Source: OptionsHouse

Meanwhile, yesterday afternoon the White House announced it would pull the US out of the Iran nuclear deal and restore sanctions on Iran—a development some analysts believe could support higher long-term oil prices.3  June crude oil futures (CLM8), which had dropped to $68.02/barrel in yesterday morning, spiked above $70 on the announcement before pulling back to the $69.50-$70 range.


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1 Reuters. Gold as an inflation hedge? Well, sort of...  3/1/18.

2 Barron’s. 6 Dividend Stocks That Hedge Against Inflation. 6/5/17.

3 Trump will kill the Iran nuclear deal — and that's a 'long-lasting' boost for oil prices. 5/8/18.