The Economy is Splitting in Two: How to Trade the Rotation

The economy is in the process of literally splitting in two as we are seeing a rotation take place. And what I want to do in this video is explain how

exactly the different moving parts of the economy are developing right now and what that exactly means for rotations in financial markets. So that is what I'm

financial markets. So that is what I'm going to be laying out today. Everything

starts with understanding this chart and the one that follows. You will notice that right here in the chart, the ISM manufacturing index has been spiking up

pretty significantly. At the same time,

pretty significantly. At the same time, right here, month- over-month, retail sales have actually turned negative just marginally. Now, the reason why this is

marginally. Now, the reason why this is important is because we are seeing certain parts of the economy like the manufacturing side begin to accelerate

while retail sales are flat or negative.

And that's not just with those data prints. Those represent the entire

prints. Those represent the entire picture that is taking place because when we look at things like US durable goods here in white, same thing happening right now. You have an

acceleration that is taking place in investment and cyclical conditions as well as in blue here, industrial production. Now, if you want any of

production. Now, if you want any of these charts, they'll be laid out below for free for paid subscribers. And I'm

going to be breaking down how exactly these factors are beginning to play out for a report linked below. But the key thing to take away from this chart is

that we are seeing an acceleration of growth specifically in investment and US industrial production and durable goods.

Now this is connected to the rotations we are seeing in markets. Notice that

the industrial sector of the S&P 500 has been accelerating and is at all-time highs. That is in stark contrast with

highs. That is in stark contrast with the software sector of the entire market. If you understand this rotation,

market. If you understand this rotation, it is going to begin to frame how you should think about the probability of recession, inflation, and how things are shifting in markets. Because I'm going to cover this in one moment in a couple

charts, but there has been a shift that has taken place where the major impulse in markets has changed. And that's

really changed the rules and the playbook for how to think about price action. And a lot of that has connected

action. And a lot of that has connected to the fact that here is the 3month rate of change in NFP. You've seen NFP really decelerate over the last couple of

years, but notice that this most recent change has spiked up on a 3-month basis and then also on a one-mon basis, you have seen the last print last week come in above expectations. Now, here's where

consensus is kind of going off. We have

been in a period of time where the labor market is contracting a bit, but then we had a single print that began to come in and surprise expectations. That's what

this is right here. Now, the question is, is this going to continue up or is it going to move back down? Here's a key way that you want to think about that.

Notice in bonds right here, they have been rallying over the last couple of weeks. You had the Jolts print come in,

weeks. You had the Jolts print come in, which caused a bid in bonds and it held this level right here. Then we came into NFP and notice we sold off in NFP on

that hotter NFP print in bonds. But

notice this level right here, which is the same jolts level that we were at.

That level held and we are now rallying higher above that and holding these higher levels right here. Now, the

reason why that's important is because bonds reflect longer term nominal growth expectations. If we were truly having a

expectations. If we were truly having a reaceleration in the labor market, you would have bond prices below this NFP level right here, but we are actually

higher. The implication of that is that

higher. The implication of that is that the market is looking through and sniffing out the weaker growth that is currently taking place in the underlying

economy due to these bigger changes that are taking place in this rotation where we have again you have industrial side of things accelerating a lot of that is due to the AI investment that is taking

place but when we look at things like retail sales they're actually negative right now and then when we look at the labor market again we had one single print that was Not, but is that going to persist? The bond market is saying that

persist? The bond market is saying that that is unlikely. And so the long end of the curve is pricing that reality. Now,

here is the chart that you really want to understand for everything that's going to play out over the next couple of months. If you understand this logic,

of months. If you understand this logic, it's going to be incredibly helpful to filter through all of the noise. Here's

a chart of credit spreads in blue and then inflation swaps in white. Credit

spreads are primarily pricing growth risk in the economy. Inflation swaps are primarily pricing inflation risk. Makes

sense. Now notice during this period of time recently in blue you had credit spreads drop as inflation swaps rose.

Why was that? That was during the period of time when you had inflation beginning to shift considerably. So when we had

inflation swap ever since the tariffs up here fall, that was inflation expectations beginning to fall. And now

what we're having is them roll over again, but this time you have credit spreads beginning to rise. This

relationship is important to know because if you have credit spreads, excuse me, inflation swaps falling as credit spreads are rising, that tells you that the major risk and impulse in

markets is on the growth side. It is the market saying, "Hey, there actually might be some growth concerns because you have credit spreads rising as inflation swaps fall." Now the question is to say, okay, is this going to have

persistence? How should we think about

persistence? How should we think about the scenario analysis of this? That all

comes down to how should we think about CPI and the inflation prints that are going to come out. Now, the last CPI print that came out came out to indicate a little bit of development, but the key thing for this week will be the PCE

print. If you want to go through how

print. If you want to go through how some of these prints work in the report linked below for paid subscribers, I'm going to give you the entire CPI base effects models that I have that breaks

down what are the drivers that are taking place and how should we think about the upward or downward pressure of base effects as we move into the next print for CPI. But the PCE print this

week is going to be really important to get us a view into what is inflation really doing right now? How should we think about that taking place? And so

again, this entire dashboard will be linked below 100% uh for paid subscribers, but there'll also be other models linked below this entire slide deck uh for free and I'll I'll explain those at the end of this video. But if

you want this CPI model, it'll map the rate of change, the scenario analysis, and then also the base effects and how those function. The PCE print, notice

those function. The PCE print, notice right here in core PCE on a year-over-year basis, consensus is projecting 2.9. The last print was 2.8.

projecting 2.9. The last print was 2.8.

Now, the reason that matters is because if this comes in below expectations, it's going to provide a lot more support to bonds. Now, if you were following the

to bonds. Now, if you were following the research that I put out on the Substack, one of the key anchoring points we have for this year is where is the Z6 contract, which is the December 2026

contract pricing rate cuts for the end of this year. Simply put, how many rate cuts are we going to have this year from the Fed? The market always prices that

the Fed? The market always prices that reality for what the Fed is going to do and long end rates are simply a derivative of that pricing whether it is right or wrong as the Fed is conducting

their forward guidance. Right here at this level we have the Fed and the forward curve pricing 50 bips of cuts and you have 75 bips of cuts up here at

this level. Now one of the things that I

this level. Now one of the things that I laid out in the recent report was that and this was you know February 9th that my view was that rate expectations will

anchor around 50 pips in Z6 which means that there's this floor and when we priced almost 25 pips in Jan you know that was a bit of an extreme and so that's why I shared the ZT long and so

if you notice that ever since this time ZT has been rallying since February 9th and the reason why is if you can understand the floors and ceilings that take place in these sofer contracts

you can begin to understand what bonds are likely to do as we move forward. If

you understand bonds and this idea of the rotation connected to the software sector and industrial production, you're really going to begin to understand the underlying rotation in the economy and

saying how is AI creating retooling or changes in cyclical conditions because it's creating investment right now and how is that connecting to interest rates and US equities in these changes for

software and then industrial production and the industrial sector overall. If

you can map those changes and then weight them so that you understand again tech and software much larger waiting in the index than industrial production which makes sense because the S&P 500 has been in a range for the last week or

so. And I'll go to this chart of the S&P

so. And I'll go to this chart of the S&P 500. You'll notice that we've been

500. You'll notice that we've been rangebound for a little bit and we've bounced against these lower levels of 6,800. And the question is, are we going

6,800. And the question is, are we going to move down below this or begin to break to an all-time high? And that way that we really begin to think about how

those drivers exist is by understanding the rotation and those drivers. So we're

shifting to say, okay, growth is one of the major things that's driving markets now as opposed to inflation risk. Notice

right here, this is why you want to understand the curve. We have been bull flattening over the last week or so.

Notice bull flattening right here. By

the way, if you want this model, it'll be linked below. I'll share it with you.

We have been in this red regime right now and we've been flattening in the curve which means long-end bonds are rallying more than shortend pricing. So

that means that the long end is sniffing out some of the growth risk that is taking place. And on top of that if we

taking place. And on top of that if we have some material progress in inflation toward 2% which is why understanding this model that I'm going to lay out is really key and the base effects that are

existing in the next two prints. If you

understand that, then you'll begin to frame, okay, should I be taking longs here or is this where I should really be a lot more cautious if we break below these levels? And so this incremental

these levels? And so this incremental process of saying, okay, what are the drivers? How are they impacting things?

drivers? How are they impacting things?

Broadly speaking, equities remain skewed to the upside on a cyclical basis in the strategy that I'm running. Okay, so

that's the big picture view. But the

question is, how do we incrementally understand the data points and drivers at these different extremes that are taking place at these levels? And so

that is what I'm going to lay out below for paid subscribers in the report, as well as a bunch of models and the high conviction trades that I'm taking as we move into the next 30 days. Here is what

I will say as an ending note for you.

Clarity is not a moment, it's a habit.

So markets don't just reveal themselves all at once. They reveal themsel incrementally across assets in small details that only connect if you're paying attention. And that is really the

paying attention. And that is really the key. You want to always be in the

key. You want to always be in the process of pulling together these data points, understanding why things are taking place and updating your view incrementally through time instead of all at once through, you know, one

period of time or something like that.

The edge is never in a single data point. It's in the process of watching

point. It's in the process of watching one market tell you something about the other market hasn't priced yet. and

doing that every day until the picture becomes obvious so that you know you are able to extract those returns. You

cannot zone you cannot zone in for the payoff and zone out for the process.

That's one of the key things that I always tell people. The people who see rotations early don't have better information. They just have a daily

information. They just have a daily practice of asking what has changed, what hasn't adjusted, and what is the gap worth for extracting returns. And

again, if you're brand new and trying to understand everything that I'm putting out, my entire goal is twofold. Number

one, map the macro regime. And number

two, take home run bets within that. And

all of the research that I put out falls into those categories. And so if you go to the capital flows research website, there is an entire educational primer section with all the PDF playbooks for

how to think about macro and markets, an entire list of book recommendations, and there is an entire suite of models from Trading View. I'd also encourage people

Trading View. I'd also encourage people use the CME tool and quickstrike if you don't have a Bloomberg. All of these are 100% free. So, if you go on to the

100% free. So, if you go on to the Capital Flows Research website right here on the main page, all of these reports and indicators are free and you can go through all of those. And then in this top section, here's how I

categorize everything with the macro reports, equity, strategy, and interest rate FX reports. All of the idea behind this is that you want to understand what are the macro forces that are taking

place. How do those create headwinds or

place. How do those create headwinds or tailwinds for my positions? And then

within that framework, how do I take larger asymmetric bets? So that is what I'm going to be laying out further on the Capital Flows Research website in the report linked below for paid subscribers. If you guys want to be a

subscribers. If you guys want to be a paid subscriber, you can do so at capitalflows research.com. And with

capitalflows research.com. And with

that, I will see you guys