Another great week for markets

The Week that was.

 Another great week for markets and a continuation of the trend that started 3 weeks ago - bond yields continued ease downwards (meaning bond prices firmed) while markets continued their ascent, and with remarkably little volatility. The earnings season in the US has started well and there are increasing signs of just how robust the economic rebound in the US is proving to be. Many investors would have expected this to put further upwards pressure on bond yields (as they have in Europe) but US Fed Chair Jerome Powell has been at pains at every appearance to reassure markets that the Fed is no hurry at all to raise rates and he seems to have been quite successful in talking down rate expectations. That is the fundamental explanation for the surprisingly different views of the bond and equity markets. A more technical one might be the sheer volume of retail flows (much of it apparently originating with government stimulus checks) into equity markets. We have seen one statistic suggesting that this amounts to over a half a trillion US dollars in the last 5 months, more than in the last 12 years prior to that.

Last week, and indeed over the last three weeks, the standout performers were materials and tech which meant that the Australia, the UK (materials) and the US (tech) outperformed. While the tech sector is a relatively small part of our local index (less than 5%) such has been the rebound in the last 3 weeks of stocks like Afterpay (up 25%) that it has actually contributed quite significantly to the local market’s gains this month. 

Commodity prices in general were buoyant last week underscoring the fact that expectations for a sustained recovery continue to build. Lastly, as mentioned government bond markets firmed, and credit markets remain just as sanguine as they have been all year. Helpfully, bond market-based inflation expectations have plateaued in the last few weeks which has perhaps made Chair Powell’s job a bit easier but other measures including so-called ’nowcasts’ (real-time estimates) continue to rise as does the anecdotal evidence of both demand driven inflationary pressure (strong economic activity) as well as less benign pressure from supply chain disruption and perhaps nascent de-globalisation. Last week saw more delays announced in car deliveries as a result of the global shortage in micro-chips but for now at least the market is resolutely looking through this hopefully short-term noise. 

?What we are watching and working on.

• Our UK correspondent flagged many months ago how markets would look through the inflation figures we are seeing now, which is exactly what is now happening. He has also made the case with increasing vigour that ultimately these pressures may not dissipate as fast as the market hoped. It will be a few months before we know either way but, given the currently sanguine attitude of markets, there remains a risk that a marked rise in inflation expectations could still spook markets. By way of reference the Bloomberg survey of economists has inflation forecast to peak in the second quarter of 2021 at just over 3% both here and in the US, much as it did following the bounce out of the GFC. From that point it is expected to subside back to just over 2% by the end of the year. This is exactly the Fed’s playbook and the distribution of forecasts around this number is quite narrow (the consensus is strong). This means that at some point in the next few months the Fed and the markets will either manage to thread this needle or something else will happen, something that may well upset both bond and equity markets. Last week we did some modelling on long-term return expectations in different inflationary regimes on a sector by sector basis. One thing that came out of that was that the scenarios with higher inflation involve a potentially violent shift in interest rate expectations that is not currently priced into markets - put simply higher GDP in the future is not coherent with cash and interest rates that are several percent below rising levels of inflation. While we work through these scenarios it seems likely that data will shift as quickly as we ‘do the work’.
• Our UK correspondent also warned us quite presciently of two other issues last year that ended up in newspapers last week. Firstly, he started to raise the ‘spectre’ of US banks becoming awash with deposits, to the point of indigestion. Last week Jamie Dimon of JP Morgan intimated that exactly this was happening and despite record results the share price of the bank fell as he warned of the banks inability to put that much deposit. money to work. This is a timely reminder of the many more unintended consequences that were are likely to see as a result of COVID and the unusual policy responses. Secondly, our correspondent has long suggested that at some point the US would ‘weaponise’ the US financial system. That time appears to have come and, with China already trying to de-leverage, that aspect of Sino-US relations may now be something to keep an eye on more actively.
• Lastly, earnings season in the US starts in earnest next week and while the data will continue tone noisy and littered with unusual COVID related ‘base effects’ we think the commentary and outlook form many of the large bellwether stocks could be quite interesting. Early in the week Coca-Cola, IBM, J&J, Proctor & Gamble and Netflix are of particular note.