Market Outlook: Conventional Wisdom on Duration and Beta is Flawed

Mark Meldrum argues that prevailing market narratives have led to a significant mispricing of both duration and beta. He contends that long-term Treasuries are unduly suppressed while large-cap equity valuations are unsustainably high, presenting unique opportunities for discerning investors.

Key Insights

The Mispricing of Duration: Long-Term Treasuries Undervalued

Attribution: Mark Meldrum

"I'm going to make the case here that the long end of the curve, the 20 to the 30 year mostly represented by TLT is wrong. It's absolutely wrong. And that TLT should be much higher except for, for the narrative."

Mark Meldrum posits that the long end of the Treasury curve, particularly instruments like TLT (20+ Year Treasury Bond ETF), is significantly undervalued. He argues that its current pricing does not reflect fundamental strength but is instead suppressed by a prevailing negative narrative and substantial short interest. Despite recent benign CPI and PPI readings, a well-bid 30-year auction, and geopolitical uncertainty that typically favors safe-haven assets, long-duration Treasuries have failed to sustain gains. Meldrum attributes this to a market driven by traders playing a narrative rather than long-term investors assessing fundamentals. He points to historically high short interest in TLT (19-24% of float) and significant short positions in Treasury futures (1.85 million contracts as of June 3rd) as primary drivers of selling pressure. This pressure, he explains, forces authorized participants in the ETF market to sell underlying bonds to arbitrage price discrepancies, further weighing on bond prices.

Conversely, Meldrum highlights several underlying factors supporting higher prices for long-duration Treasuries. Strong auction demand persists across the curve, with bid-to-cover ratios for 10-year and 30-year bonds remaining robust (e.g., 30-year bid-to-cover consistently above 2.2x). He also anticipates a significant tailwind from the proliferation of stablecoins, which will necessitate large-scale purchases of T-bills and other short-term government debt, potentially pushing demand further out the curve and flattening it. Furthermore, the deflationary impact of AI is a major, yet underappreciated, factor that should support lower long-term yields. Meldrum believes the current selling pressure is a crowded trade based on a narrative that will eventually yield to these stronger fundamentals.

Actionable Takeaway: Investors should consider that the current weakness in long-duration Treasuries may be a temporary phenomenon driven by technicals and sentiment rather than a reflection of true credit risk or poor demand. Opportunities may exist for those willing to look past the prevailing narrative and position for a potential rally in TLT as fundamentals reassert themselves. Meldrum himself is long TLT.

Large-Cap Beta Overvaluation: A Market Ignoring Fundamentals

Attribution: Mark Meldrum

"Something is wrong. Either the real rates are too high and they've got to come down or the equity market is valued too much and it has to come down. One of these markets is wrong. I'm going to make the case later that both markets are wrong."

Mark Meldrum expresses strong conviction that large-cap equity beta, exemplified by the SPX, is overvalued. He points to elevated real rates (e.g., 10-year real rates around 2.13-2.64%, levels not seen consistently since 2008-2009) which are typically negative for equities, yet the market continues to ignore this signal. The S&P 500's forward P/E ratio of 22.17 on operating earnings is high, especially when considering the modest earnings growth of the S&P 500 excluding the "Mag 7" (e.g., 7% estimated growth for S&P 500 ex-Mag 7, implying a PEG ratio around 3). Meldrum argues this valuation is not justified by underlying economic profit principles, where competitive forces should drive economic profit (profit after cost of equity) to zero, thereby anchoring valuation multiples.

He suggests that the current high multiples in large-cap indices are sustained by monopolistic or near-monopolistic characteristics of dominant companies, which resist the natural reversion of economic profit. However, he foresees headwinds for these large caps, including increased legislative and regulatory scrutiny targeting monopolistic practices (citing issues faced by Google, Apple, Amazon). Additionally, Meldrum criticizes the market's ingrained behavior of buying every dip, a "V-shaped recovery" mentality trained over 15 years, which he believes is becoming increasingly risky and ignores deteriorating fundamentals or changing market regimes.

Actionable Takeaway: Investors should exercise caution with broad large-cap equity exposure. The combination of high real rates, stretched valuations unsupported by ex-tech earnings growth, and potential regulatory headwinds suggests significant downside risk. Meldrum is actively shorting SPY (S&P 500 ETF) based on this thesis.

The Small-Cap Opportunity: Poised for Outperformance

Attribution: Mark Meldrum

"Deregulation Tends to favor small cap over large cap... The AI effect. This has the ability or gives the ability for a lot of smaller businesses to generate output or raise productivity... All of these things don't favor large cap, they favor small cap."

While bearish on large-cap beta, Mark Meldrum sees a compelling opportunity in small-cap equities, represented by indices like the IWM (Russell 2000 ETF). He argues that several structural shifts favor smaller companies. Firstly, a potential move towards deregulation would disproportionately benefit small caps, as large corporations often advocate for regulations that create barriers to entry for smaller competitors. Reducing these barriers would level the playing field.

Secondly, the AI effect, while deflationary overall, is also a democratizing force. AI tools can empower smaller businesses to enhance productivity, innovate, and compete more effectively with larger, more established firms without needing massive capital expenditure or hiring sprees. This allows them to "nibble away at the space that large cap lives in." Thirdly, the legislative pressure on large-cap monopolies, if it leads to measures that foster more competition, will inherently create a more favorable environment for smaller, nimbler companies. Meldrum notes the significant underperformance of small-cap factors over the last three years (e.g., small-cap factor underperforming SPY by 28%) suggesting a potential valuation gap and room for mean reversion.

Actionable Takeaway: Investors looking for equity upside should consider overweighting small-cap stocks relative to large-caps. The confluence of potential deregulation, the productivity-enhancing and democratizing impact of AI for smaller firms, and anti-monopoly legislative actions could create a sustained period of small-cap outperformance. Meldrum is long IWM.

AI: The Looming Deflationary Wave

Attribution: Mark Meldrum

"AI is going to be a productivity enhancing tool. It is going to lower unit costs which on a competitive basis should lower pricing. I think it's going to be massively deflationary."

Mark Meldrum emphasizes that Artificial Intelligence is not merely an incremental technological advancement but a general-purpose technology with profound economic implications, chief among them being its powerful deflationary potential. He argues that AI's ability to enhance productivity, particularly in tasks involving declarative, conceptual, and procedural knowledge, will lead to lower unit costs. In a competitive market, these cost savings should translate into lower prices for goods and services. This deflationary pressure is significant and, according to Meldrum, not yet fully priced into market expectations or inflation forecasts.

He notes that even before the full impact of AI is felt, recent inflation data (CPI and PPI) has been benign for four consecutive months, with core measures annualizing at or below the Fed's target. The Super Core CPI (core services ex-housing) annualized at a mere 0.37% over the last four months, flirting with deflation. Meldrum believes this trend will be amplified as AI adoption becomes more widespread, impacting the job market by displacing entry-level positions and enabling existing staff to achieve higher output. This productivity boom, he asserts, is a structural shift that will weigh on inflation for the foreseeable future.

Actionable Takeaway: The deflationary impact of AI is a critical long-term theme. For fixed income investors, this reinforces the case for longer duration assets, as sustained low inflation would support lower nominal yields. Equity investors should consider which sectors and companies are best positioned to leverage AI for productivity gains versus those whose business models might be disrupted.

Fed Policy: Persistently "Too Late"

Attribution: Mark Meldrum

"I think they're going to suffer from the words abundance of caution. And I think the moniker too late is going to stick with this guy. It's going to stick with this committee."

Mark Meldrum is critical of the Federal Reserve's recent policy trajectory, characterizing it as consistently "too late." He argues the Fed was late in raising rates to combat inflation and is now risking being late to cut rates despite four months of benign inflation data. He believes the Fed has sufficient "permission" from the data (annualized headline CPI at 0.9%, core CPI at 1.57% based on recent month-over-month figures) to implement a 25 basis point cut. Such a cut, he suggests, would primarily lower the government's short-term borrowing costs without significantly easing conditions at the long end of the curve, where monetary policy has its greatest capital market impact.

However, Meldrum anticipates the Fed will err on the side of "an abundance of caution," potentially citing uncertainties like geopolitical events (e.g., Iran conflict, tariffs) to delay easing. He expresses concern that this reactive, data-dependent approach, overly focused on lagging year-over-year figures rather than forward-looking annualized short-term trends, could lead to policy errors, potentially necessitating more aggressive cuts later if the economy weakens more than anticipated. He is positioned for rate cuts via ZQ (Fed Funds futures) contracts, holding a substantial long position.

Actionable Takeaway: Investors should be prepared for the Fed to maintain a cautious stance, potentially delaying rate cuts longer than some market participants expect. However, if Meldrum's view on disinflationary pressures and a slowing job market (evidenced by rising continuing claims) proves correct, the Fed may eventually be forced into more significant easing, creating opportunities in rate-sensitive assets.

Quotes

Mark Meldrum: "It is the case that the economic profit will be driven to zero... If you had a situation where the moment you had economic profit greater than zero, firms would enter the industry. It would drive pricing down... Well, that's why if that is an attractor point, that is why a forward multiple is an attractor point." (Explaining the theoretical basis for mean reversion in valuation multiples, which he believes large-cap tech is currently defying unsustainably).

Mark Meldrum: "For the last 15 years we have trained a whole generation of investors and traders to look at only one pattern on charts... Any drop like that is... half a V... because it has always worked. For the last 15 years, the V pattern has worked blindly. The pattern is agnostic to the valuation... I think that that's going to face some significant challenges going forward." (On the behavioral patterns driving equity markets and his expectation of a regime change).

Mark Meldrum: "This is your culprit right here. These are, this is the guilty party [referring to high short interest in TLT and Treasury futures]. And what are they doing? They're playing a narrative... The narrative lasts longer than the fundamentals. When the narrative can't handle the fundamentals anymore... At some point the fundamentals say you cannot ignore me anymore." (On why long-duration Treasuries are mispriced).

Market Implications

Mark Meldrum's analysis points to a market environment where conventional wisdom regarding both fixed income (duration) and equities (beta) is flawed, creating specific strategic opportunities.

His core thesis suggests that:

1. Long Duration (e.g., TLT) is an attractive buy: The current suppression of long-term Treasury prices is due to narrative-driven short interest and technical selling pressure, not fundamental weakness. Underlying factors like strong auction demand, the future demand from stablecoin reserves, and the powerful deflationary effects of AI all point to higher long-term bond prices (lower yields). Investors willing to look past the current negative sentiment may find significant value.

2. Large-Cap Equity Beta (e.g., SPY) is a compelling short: Stretched valuations, particularly when excluding the "Mag 7," high real interest rates, and looming regulatory/legislative headwinds for dominant tech companies suggest large-cap indices are vulnerable. The ingrained "buy-the-dip" mentality may falter as these pressures mount.

3. Small-Cap Equity Beta (e.g., IWM) offers relative outperformance: Factors such as potential deregulation, the democratizing and productivity-enhancing impact of AI for smaller firms, and anti-monopoly actions against large caps create a favorable backdrop for small-cap equities to outperform their larger counterparts.

To capitalize on these insights, Meldrum outlines his own positioning: long duration (TLT), short large-cap beta (SPY), and long small-cap beta (IWM). He emphasizes a tactical approach to shorting, using options to manage risk and capitalize on volatility, while holding his long positions with a longer-term conviction. The overarching strategy is to position against crowded narratives that ignore burgeoning fundamental shifts, particularly the deflationary power of AI and the unsustainability of current market structures in large-cap tech.