Thursday, Dec 10Hamish Risk | December 10, 2020
In recent years we’ve had the climate deniers, and then more recently the Covid deniers. In our world of macroeconomics and investing we’ve had our own set of deniers; the inflation deniers. To be fair, this crowd – and they’re a big crowd – have had the data on their side, and the inflationists have cried wolf aplenty. So the deflationists have held the higher ground. Then, in recent years the media crowd have jumped on the bandwagon with their Francis Fukuyama-esque proclamations of the ”end of inflation.” But we’re not here to pick sides, we just appreciate rigorous analysis and original thinking from our privileged position of being able to read a wide range of research from across the market. We just note that the inflation crowd is getting larger, and maybe for good reason. Today we highlight some new research from Andrew Hunt Economics who has produced a report containing fifty of the firm’s favourite charts on the outlook for inflation. The results appear surprisingly conclusive, which is, that inflation is on the cusp of a major turning point and is set to surprise markets on the upside next year. Meanwhile, Vincent Deluard of StoneX, one of our favourite original thinkers, explains why inflation will be the catalyst that breaks the perpetual upward motion of the stock market, as well as slaughtering bonds. It’s a point picked up on by Constance Everson from the Capital Markets Outlook Group, who recommends shifts in fixed income allocations, where allowed, or tactical moves away from fixed income, as near-zero sovereign yields and heavy competition for expensive corporate bonds increases the need to diversify into other assets. Meanwhile in equities she says investors are being whipsawed between safe-haven tech stocks and cyclical stocks as leadership chops and changes, meaning rotation remains stuck in gear. That’s possibly because it’s dawning on investors that the upbeat forecasts US GDP in 2021 aren’t going to be met, says Keith Grindlay from Macro Thoughts. To keep things afloat, that probably means more debt, and as Julian Brigden from MI2 Partners highlights below, the latest academic thinking on a new paradigm for debt/GDP reaffirms exactly what central bankers and policymakers were hoping for; an argument that justifies huge borrowing and fiscal spending in a bid to support growth. But will there be a cost to pay?
Inflation Andrew Hunt Economics
1. Inflation – the curse of the pressAs Andrew Hunt recounts, awards can be something of a joke in economic circles. Take the “Finance Minister of the Year” award handed out by a prominent investment magazine in the 1980s and 1990s. More often than not, he says, the winner would be in crisis the year after receiving the award, given that the media would have seen an economy doing well the year before– but not the credit boom that got it there. Hunt makes the point because another prominent magazine has just published an article claiming Milton Friedman was wrong, and that inflation, to all intents and purposes, is now officially dead. That is exactly the sort of thing that happens when you ask what else could possibly go wrong now? And then a piano crashes on your head. Indeed, Hunt lays out, with a selection of 50 charts, why there are a number of strong theoretical – and data related – reasons why that article on inflation was wrong, and why inflation is on the cusp of a major turning point and is set to surprise markets on the upside next year.
bitcoin bonds Global equities gold Inflation StoneX
2. How the perpetual motion stock market will breakIn a typically thoughtful piece, Vincent Deluard outlines the things that will stop the seemingly relentless rise of the stock market. Inflation is the most immediate risk, he says, as it would slaughter bonds, lower equities’ multiples and destroy the strategies that rely on the negative correlation between the two assets classes. Those strategies are also at risk from gold and cryptocurrencies which have both outperformed the 60/40 equity/bond approach for the last four years, adds Deluard, who explains why the latter are a game-changer which allow investors to bypass the financial system. Importantly, Deluard explains why a new era of populism will transform the cyclical inflation of 2021 into a decade or more of secular inflation.
equity market leadership Capital Markets Outlook Group
3. A jagged pathway towards recovery for equity investorsEquity markets face the risk that the page has turned on shares that do well in a no-growth environment without establishing firmly enough a case for new leadership. Constance Everson from Capital Markets Outlook Group describes this tug of war that persisted into November, between the mega-cap tech names, and more economically-sensitive stocks. She points out it has been necessary to have exposure on both sides, and this could well remain so, despite optimism for more normal growth in 2021. From an asset allocation standpoint, Everson suggests shifts in fixed income allocations, where allowed, or tactical moves away from fixed income as near-zero sovereign yields and heavy competition for expensive corporate bonds is increasing the need to diversify into other assets. Her preferred destination is public equities, for their liquidity and transparency, alongside a range of strategies intended to dampen volatility. Examples of those are hedged equities, income alternatives, treasury bonds, used on a tactical basis, and short positions in assets with asymmetric return patterns.
bond yields US economic recovery Macro Thoughts
4. Higher yields – but will US GDP meet expectationsKeith Grindlay at Macro Thoughts delivers a reality check to those forecasting US growth in the region of 5% next year on the back of the arrival of Covid-19 vaccines. With lockdowns still likely across most of the first quarter and the virus still spreading like wildfire, he says those predictions are likely to be too optimistic. Markets, warns Grindlay, have been quick to react to those upbeat forecasts, but may be in for disappointment amid a weakening dollar, higher food inflation and higher productivity costs – not to mention the psychological impact of the pandemic.
debt/GDP levels MI2 Partners
5. Debt/GDP – the infinite horizonThe latest note from Julian Brigden at MI2 Partners pours scorn on the latest academic thinking that just happens to do exactly what central bankers and policymakers were hoping for, proposing that in the current environment “traditional” views of the dangers of debt and deficits don’t apply. Conveniently, he says believing the new “infinite horizon GDP” mantra that says debt service costs are likely to be much lower in the future means policymakers can justify huge borrowing and fiscal spending in a bid to support growth. No question, says Brigden, this academic blank check will be welcomed by the Biden Administration, but the endorsement may also speed up a generational inflection point, ushering in forces that could upend the accepted political and economic status quo. Click here to contact us for the full report and discover why the policy could herald the end of US exceptionalism.