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Editor's Note: Hamish Risk | May 22, 2020
In today’s briefing we highlight a mix of themes covered by analysts in a week when there was renewed optimism of a vaccine breakthrough that will (with further evidence) give a major boost to the global economy and asset prices. When assessing how equity markets have performed since the end of March, Cornerstone Macro shows how a clear picture has emerged, “high-quality growth” has prospered, and ”higher-beta and lower quality cyclicals” have been left behind. But that could be about to change, say Ollari Consulting. A vaccine is clearly a game changer, so, with ample liquidity on the table (not a given, see this piece), there could be a strong possibility that we see a significant market rotation in the coming months where pro-cyclical sectors, small caps, value, high beta outperform. Throw in a weaker US dollar as economic confidence returns, and you add further fuel the reflationary narrative. This begs the question about inflation, it’s a hotly debated and searched topic (hat tip Top Down Charts), and Longview Economics make the case that in this cycle, the deflationists have it wrong (i.e. Inflation didn’t return after the GFC, so why would it now?). Longview argue that two key ingredients (less prevalent then) for high and rising inflation over the medium term – large levels of money stock and rising money velocity – are now in place. In other research, SouthBay Research, one of the market’s top forecasters on US employment data, points out that official jobless claims data are overstating the number of unemployment claims. The jobs market has been in recovery for 2-weeks now. And lastly, while DM economies start looking more promising, the picture in EM is worsening, with emerging market specialists Tellimer highlighting how precarious the finances are in emerging and frontier economies. Just in the last month, the number of countries seeking help from the IMF has surged by almost 60%.
Inflation Longview Economics
1. Beyond the reckoning – inflation or deflationIn the near term, it’s clear that the world is deflationary says Longview Economics senior market strategist Harry Colvin. After all, he says, inflation readings are sharply lower; money velocity is contracting; the oil price is weak; and the economy has turned down sharply creating an increasingly large output gap. All of that speaks to a theme which Colvin calls ‘The Reckoning’, which should be a deflationary force on the US and global economy at least for the next 6 – 24 months. Beyond that timeframe, though, there is a contentious debate around whether inflation will meaningfully reaccelerate in the next economic cycle, he says. The ‘deflationists’ suggest that this crisis will leave the US and global economy with even more debt and zombie businesses, according to Colvin. They also, he says, highlight the lack of inflation post the GFC – despite large levels of money creation and initial fiscal easing. The evidence suggests it will be different this time, however, argues Colvin, with the two key ingredients for high and rising inflation over the medium term – large levels of money stock and rising money velocity -now in place.
Emerging markets Tellimer
2. IMF emergency financing tracker; EM/Frontier countries seeking funding has spiraled this monthTellimer, the EM and frontier markets specialists, have been publishing regular updates on their IMF emergency financing tracker, and it provides a fairly bleak picture of how quickly the finances of emerging nations are worsening in the face of COVID-19. Tellimer’s latest update captures 72 countries that they know of so far that have either sought, or are seeking, emergency help from the IMF or have made drawings under their existing arrangements, or are seeking new ones, in response to the pandemic. This is up from 58 in the last two weeks, and from 31 just one month ago. In terms of actual disbursements, 53 countries have now received funding from the IMF with the total amount disbursed under these facilities totalling US$20.9 billion. Tellimer say that according to the IMF board schedule, there should be two more approvals today (Jordan and St Vincent).
US economy US unemployment SouthBay Research
3. Is there a mistake in the jobless claims data?The market’s most accurate forecaster for jobless claims says the official numbers are wrong. The US jobs market bottomed 2 weeks ago, according to SouthBay Research, which says the US Department of Labour has made a methodological error that has unnecessarily added 2.2 million to the ongoing claims count. The error, says the firm, centres around the DoL’s practice of seasonally adjusting the data, in this case by a factor of 9.3%. While that may make sense in more normal times, say when claims are around 1.5 million, when, as now, they are an order of magnitude higher at around 22 million, the practice seriously distorts the real figures. The bottom line, says SouthBay, is that non-seasonally adjusted data shows the US has reached peak ongoing unemployment, and conditions are already improving, with small cities outperforming the large in the early stages of recovery.
equity breadth style Cornerstone Macro
4. Finding winners amidst zombie fundamentalsIn the firm’s latest equity strategy note, Cornerstone Macro’s Michael Kantrowitz explains why he has stuck with his “high-quality growth” recommendation while the stock market has made large gains over the past two months. While many were expecting a sharp rotation back into riskier segments of the market, it just hasn’t happened, he notes, while even with the S&P 500 now back near 2900, some investors are still expecting, if not wanting, to see a rotation back into higher-beta and lower quality cyclicals. Kantrowitz says those stocks have missed the boat with regards to relative performance, however, as the best odds of low-quality leadership is usually from the lows. He says riskier stocks have not led the rally this time due to the unprecedented uncertainty brought on by the new macro-factor driving the business cycle – a virus. While we all expect some short-term improvement in the data, the road ahead is going to be a rocky one and we simply don’t think investors will have the conviction to take on much risk, adds Kantrowitz. He highlights the record-high bankruptcy risks that models are pointing to – a backdrop where quality will likely remain paramount.
equity rotation Risk assets Ollari Consulting
5. Rotation or notTwo weeks ago Ollari Consulting wrote this piece where they argued while fighting the Central banks’ liquidity had been and still is a losing strategy, there was little that central banks could do in front of a brutal re-ignition of the conflict between the US/DM economies and China at a time when the world economy is in limbo, and we were quickly moving closer to that point. Fast forward two weeks, the geopolitical optics haven’t got much better, yet the risk assets haven’t budged. Ollari says these US-China tensions will prevail and likely intensify going into the November’s elections, but a never-ending policy support, more fiscal expansion, the still prevailing FOMO feeling and now potential positive developments on the vaccine side, are all powerful tailwinds that will make a meaningful pullback less and less likely. So in this note Ollari has recast his views, to make the case for a significant market rotation in the coming months. Ollari says that if the “Chinese story” gets any traction and proves durable, coupled with the vaccine reports, it could feed into inflation expectations, slightly bear steepen curves, and help bolster cyclicals and other names that have lagged secular growth stocks in the latter stages of the bounce off the March lows. The US dollar will be crucial here, they say. Despite the risk rally, its remained stubbornly strong, but Ollari reckons that a vaccine and hopes that a synchronous recovery and the subsequent resumption of the international trade could unfold would become a catalyst for a more sustained US dollar normalisation that would further fuel the reflationary narrative. This essentially means that higher equities/risk assets will be driven by pro-cyclical sectors, small caps, value, high beta. In other words by the recent laggards that will outperform the stars of the last few weeks (months/years): growth, large techs, momentum, defensives, bond proxies.