LARRY KUDLOW: For the midterms, it’s still early in the game

Recent economic indicators cited include a combined ISM purchasing managers' index for manufacturing and services at its best level in nearly two years, with a cited productivity boom and wages outstripping inflation. Political data show improving personal financial sentiment in a Harvard CAPS/Harris poll and strong support for restrictive immigration and a platform of lower spending and taxes, while fundraising figures indicate substantial campaign firepower for President Trump—$26 million from his joint fundraising committee in H2 last year, $8 million to his leadership PAC, and a linked super PAC holding more than $300 million (roughly $375 million total). Together these data suggest a constructive macro backdrop and significant political capital that could influence fiscal and trade policy expectations ahead of the midterms.

Analysis

Market structure: A credible narrative of stronger growth (ISM up, wages > inflation) favors cyclicals, small-caps and commodity-exposed names — industrials (XLI), consumer discretionary (XLY), regional banks/financials (XLF) and copper/mining (FCX/COPX) are primary beneficiaries as pricing power and loan growth expectations rise. Defensives and long-duration growth (XLV, XLRE, XLK mega-caps) are the losers as discount rates and real yields rise; expect 3–6 month relative outperformance of cyclical baskets by mid-to-high single digits if macro momentum persists.

Risk assessment: Tail risks include a surprise policy shock (major tariff/immigration move) or an unexpected midterm outcome that re-prices policy risk — each could flip sentiment in days and widen credit spreads by 50–150bp. Time horizons differ: immediate (days) — volatility spikes on polls/fundraising headlines; short-term (weeks/months) — data-driven rotation around ISM/payrolls; long-term (quarters) — fiscal/tax policy changes that structurally alter earnings and rates. Hidden dependencies: sustained consumer strength depends on real wage growth continuing vs. one-off rebates; catalysts to accelerate the trade are ISM >55, payrolls beat >300k, or 10y yield >3.6%.

Trade implications: Favor modest, size-constrained rotation into cyclical ETFs and miners while protecting duration — use 2–4% tactical exposures (IWM/XLY/XLF/FCX) and hedge rates via options or short-duration inverse Treasuries. FX and rates: a stronger growth/less-dovish-Fed mix supports USD (UUP) and TIPS (TIP) on higher real yields; commodity exposure to copper/oil is attractive if PMI holds above 52 for two consecutive months. Options: use defined-risk call spreads on cyclicals and buy puts on 7–10yr Treasuries (IEF) as asymmetric protection.

Key Decisions for Investors

• Establish a 2% portfolio position via a 3-month bull call spread on XLY (buy 3-month 5% ITM call, sell 15% OTM call) to capture cyclical rotation; target asymmetric payoff with max loss = premium and target 20–40% spread return if XLY outperforms in 3 months.
• Implement a 3% pair trade: long XLF (1.8%) and short XLK (1.2%) via ETFs for 3–6 months to play financials/rotation vs long-duration tech. Exit if the pair moves against you by 5% in a rolling 10-day window or if 10y yield falls below 3.0%.
• Buy 1% notional of 3-month ATM puts on IEF (7–10yr Treasury ETF) sized to hedge duration risk; unwind if 10y yield breaches 3.6% (puts likely profitable) or if yields drop below 2.8% (time decay unacceptable).
• Allocate 1.5% to FCX (Freeport-McMoRan) equity exposure to play industrial metals on sustained PMI >52 for two consecutive months or copper futures +5% in 30 days; take profits at +30–50% or cut loss at -15%.