Let me share one of my favorite trading quotes with you, it’s from Market Wizard Bruce Kovner. He said (emphasis mine):

One of the jobs of a good trader is to imagine alternative scenarios. I try to form many different mental pictures of what the world should be like and wait for one of them to be confirmed. You keep trying them on one at a time. Inevitably, most of these pictures will turn out to be wrong — that is, only a few elements of the picture may prove correct. But then, all of a sudden, you will find that in one picture, nine out of ten elements click. That scenario then becomes your image of the world reality.

This is an important concept to always keep front of mind… even more so now.

Looking out at the macro environment I see a ton of moving, diverging, opposing variables. All of which can whip markets in a multitude of directions and speeds going forward. Dominant market narratives are coming and going faster than Trump staff members. It’s making for an interesting macro game, for sure. And the way to play this environment successfully is to imagine alternative scenarios and wait for one of them to be confirmed.

So let’s do that.

Let’s explore a few potential macro scenarios. Try them on and see how they fit. And hopefully, we’ll come away with a better understanding of how to make money in the evolving landscape and also how to protect the money we have  — both of which will be equally important in the months ahead.

Reflation Scenario — The “Overheat Phase” of our Investment Clock framework

This is the scenario we latched onto in the summer of last year. It was appealing and had a lot of things going for it.

It was contrary to the popular market narrative of “lower inflation for longer” that was predicated on continued US dollar strength, weak commodities, and low inflation expectations. All of which had become crowded trades.

In addition, we were seeing increasing macro evidence in the data that those assumptions were wrong. That in fact, sentiment was still too negative and growth should surprise to the upside. The supply and demand fundamentals for many commodities were rapidly improving. And the dollar was susceptible to a large sell-off in order to rebalance one-sided positioning.

This scenario has largely played out. Economic strength has surprised to the upside. Commodities have recovered, the dollar sold off, and bonds repriced on upward revisions to growth and inflation expectations.

And a lot of macro data continues to support this scenario.

Things like the Global Composite Purchasing Managers Index, or PMI, recently hit multi-year highs (chart via Yardeni.com).

The primary trend in global equities is up and the trend is supported by very strong earnings.

Global earnings momentum is actually at its highest level in 8-years.

None of these are bearish. In fact, things look pretty dang bullish… especially over the intermediate term. A recession this year is very very unlikely.

But, this narrative has now become one of the popular market narratives. That means that expectations are now higher and positioning in this thematic is more crowded — hence, much of the narrative is adequately priced in.