Assessing a post-COVID global asset price bust

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For the past few months, MB has been formulating a risk case for equities that has been steadily growing in our matrix of probabilities. It is that a looming triple slowdown in stimulus, Chinese and US recoveries will be enough to leave very expensive assets stranded and exposed to an adjustment. This risk case is now at a 50% probability for us so we have begun hedging it with reduced equity exposure, longer duration bonds and greater allocation offshore.

Citi Matt King today runs through some themes that central to this thesis.

He begins with the observation that actual economic activity has blasted out of lockdown:

A great recovery

A great recovery

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But to get it there, central banks blew asset prices across the spectrum:

Free money for everybody

Free money for everybody

The issue is not that the recovery isn’t good, it’s actually great. It just can’t possibly measure up to what is priced as it slows towards normalcy and ongoing structural problems:

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But it must always be MOAR

But it must always be MOAR

Always remember, rate of change is all that matters in macro:

Less more is not MOAR

Less more is not MOAR

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And the rate of change is going the wrong way:

We've seen it all before

We’ve seen it all before

Summing up:

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I remain personally concerned that the likely culprit for any correction is a China growth scare which will mean that commodities especially will be hit.

Hence hedging any correction is a matter of getting exposure to the Australian dollar while it is still high and moving out the bond curve, given the curve flattening will intensify.

That said, if said risk case does play out, it will be a terrific buying opportunity given the fiscally-led recovery in the US has many years to run.

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The question is, what will be the new asset class to buy? I have various thoughts.

  • The correction will end worries about supply-side inflation so quality growth presents itself again.
  • But, assuming it will also force the Fed to delay tapering (as well as possibly forcing China to stimulate again) it would also trigger renewed inflation expectations which will support some value.
  • Bond curves may also steepen again as MOAR Fed meets MOAR Biden fiscal triggering a worry about US wage gains.
  • This would be amplified if any correction were to force China back to more stimulus and commodities became a buy again for a short while.

Then again, the Fed might fold and China hold the line on deleveraging for longer in which case commodities would remain sidelined.

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As you can see, like so much in these pandemic markets, it is a moveable feast and being cognisant of factor rotations and staying nimble is vital to returns.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.