At the head of the queue are those that see good news as entirely good news! JPM was last into in the reflation trade and it appears it will be last out as well:
Cross-Asset Strategy: We maintain our pro-risk view given the ongoing recovery from the pandemic, accommodative monetary policy, and still moderate positioning in risky asset classes. We look for global GDP to surge in 2H as the laggards join in a more synchronized growth boom, as widespread vaccination allows for a sustained rise in mobility and economic activity. We view the recent reversal of the reopening/reflation tradeas driven by a combination of technicals (i.e.,position unwinds and systematic strategy flows in an environment of low liquidity) and overblown fears around the Delta variant’s impact on growth and mobility. In our view it is far too early to fade reopening/reflation trends, as we are in the early stages of the post-pandemic recovery (the world hasn’t reopened yet) not late-cycle, and inflation is likely to continue to realize above market expectations. The pull back thus creates a strong opportunity for investors to position for the outperformance of cyclical and value assets over bonds, defensive and growth. As such, we retain large OWs in equities (tilted towards value and cyclical) and commodities, funded by a large UW in government bonds.
I have criticised JPM before for its lack cognisance regarding China and its slowdown with regard to the whole reflation/commodities bruhaha. Amusingly, if one digs into its note, despite the headline bullishness there is this:
There are 2326 words left in this subscriber-only article.
Start your free 14-day trial today!
We believe base metal prices peaked in 2Q and will ease into the second half of the year as we are near the end of a supply-demand mismatch. Tracking for underlying ex-China demand over 1H21 has not only somewhat disappointed our expectations but is also struggling to pull ahead of a more normalized 2019 baseline level. Critical to our cautious outlook on these metals over the balance of the year is a view that despite still pretty hefty forecasted demand growth trajectories for ex-China over 2H21, we are likely moving beyond the tightest period of the year for global S&D balances as Chinese demand in particular remains constrained and, crucially, supply improves. Moreover, with global manufacturing PMIs in June downshifting and global consumption spending increasingly moving from goods to services, we continue to remain keenly focused on the 2H21 trajectory of still-fledgling ex-China metals consumption. Any stumbles here without China picking up the slack would likely leave copper and aluminum balances a bit looser than expected.
I will remind JPM that commodities have a bad habit of going up the escalator and down the lift so they are going to put a serious dent in inflation trades on the way down.
BofA is sticking to its increasingly messy good news is bad news narrative:
5P’s = down-in-Q3: Pandemic, Price, Positioning, Policy, Profits = -ve Q3 returns for credit, stock, commodities as investors discount sharp Q4 EPS/GDP slowdown; IG over HY, defensives over tech & cyclicals; infrastructure package, China easing, bull steepening of yield curve= risks to view.
Pandemic: +3bn global vaccines in H1’21 v bullish credit, commodities & stocks; and Delta variant currently belated excuse for lower bond yields & cyclicals since May 10th;but further gains in daily cases and especially hospitalizations in highly vaccinated populations will cause downward pressure on 2021 &2022 elevated GDP & EPS expectations; e.g. daily UK hospitalizations rising >1000 = negative.
Price: S&P500 trailing PE currently 30x, highest in 100 years;H1’21 = 5th best for global stocks, 5th best for commodities, 4th worst for government bonds in past 100 years; US CCC HY spread <600bps, tightest since’07; US/Canada/NZhouse prices 20-30% YoY; Wall St boom/bubble needs breather and one of world’s best risk appetite lead indicators, the Brazilian real, has failed to corroborate H2 risk-on consensus.
Positioning: BofA Bull & Bear Indicator yet to flash “sell signal” in 2021; but H1 saw remarkable inflows to stocks, TIPS, financials, materials & infrastructure funds; BofA FMS last month showed positions in“late-cycle” commodities, banks & resources highest in 15 years; GWIM equity allocation also highest in 15 years; nobody is long bonds and short stocks, but everyone a. bailing on value versus growth, b. believe US tech the Q3 hiding place rather than defensives…Q3 pain trade is SPX<4000 led by tech.
Profits: China slowing, PMI’s & EPS peaking (BofA Global EPS model predictsdeceleration fromу40% April to <20% August); biggest H2 surprise ispeak US consumer (inflation, lagging labor recovery, end of artificial stimulants cause savingsratio to remain high); note global shortages caused H1 inflation…bulls say H2 supply comes on stream, IP up, PPI down (Goldilocks); bears (like us) say C-19 dislocations continue = inflation/PPI up, IP down (stagflation); but most obvious reasonfor a negative Q3 for assets is a negative Q4 for macro (after 3-4 quarters of stunning,abnormal growth); and Wall St leads Main St so re-pricing lower of overvalued stocks & credit leading to drop in business & consumer confidence and added downside risk.
Meh, peaking global inventory supercycle, slowing China (with nothing like stimulus yet), US reopening past peak catch-up, falling commodities, declining base effects. Where’s the inflation in that?
Morgan Stanley is also good is bad news, with a twist:
Since February, financial markets have endured what we would call a “rolling correction” despite new highs being made every week in the major US equity indices. The rally in Treasuries most clearly represents what we would characterize as a risk off investment environment. This is all quite normal during a midcycle transition and the major indices remain vulnerable until they complete what should be a 20% de-rating process. So far, that de-rating has only amounted to 5%.
Pent-up Demand or Pay Back The first half of the year has been characterized by a record amount of direct stimulus to consumers and the reopening of the economy. This has been a potent combination for above trend GDP growth, revenues and profitability, a perfect set up for risky assets. However, asset prices most levered to these drivers are now under-performing broadly suggesting there may not be as much pent up demand as the consensus now is modeling. Instead, we think there could be a pay back as the stimulus fades and y/ygrowth in personal disposable income decelerates and turns negative next year.
Slowing Inventory Builds and Falling Revisions Breadth. Ultra-low inventory to sales ratios are commonly cited as a reason to expect robust rebuilds ahead. A closer look at the data suggests the ultra-low ratios are being driven by above trend sales and very depressed levels of autos inventory, but inventory in many other areas is at or above trend. We expect moderation in sales as stimulus effects fade and do not view autos as a reliable gauge for broader economic activity. Assuming modest slowing in sales (to rates still well above trend) and normalizing inventory/sales ratios (ex-autos),inventory builds will continue through year end but more slowly than the current pace. Slowing inventory builds suggest a more pronounced moderation in earnings revisions breath over the same period.
Finally, we come to the bad news is good news crew at Goldman:
How will companies preserve margins amid input cost pressures? S&P 500margins notched a record high of 11.9% in1Q 2021, though investors remain focused on the forward margin outlook given rising input costs. Global shipping woes, raw material inflation as well as acute shortages in both labor and semiconductors have combined to increase costs for companies across the economy. In the face of rising input costs, companies have been defending margins by raising prices and passing higher input costs to their customers. In our 1QBeigeBook, many companies discussed price increases and we expect this trend will continue during 2Q earnings. Alternatively, with SG&A as a share of sales elevated versus history, companies can also preserve margins through cost cutting.
How will companies prioritize their cash spending as balance sheets recover? Both aggregate and median S&P 500 cash/ assets ratios have rebounded and now stand at record levels, driven in part by record high corporate bond and follow-one quity issuance during the last 18 months (see Exhibit 4). Leverage remains elevated versus history but has been fallingas corporate profits have started to improve. InfoTech and Consumer Discretionary hold the highest cash / asset ratios of any sectors and account for43%of total S&P500 ex-Financials cash. We expect capex will represent the largest share of S&P 500 cash use in 2021, but forecast the fastest year/year growth will be in cash M&A and share buybacks. After a 10% decline in cash spending in 2020, we expectthat high cash balances, anemic yields as well as strong economic and earnings growth will combine to drive 19% growth in cash spending in 2021 ($2.8 trillion) and 6% in 2022 ($3 trillion).
How does ongoing policy uncertainty affect the business outlook? TheEconomic Policy Uncertainty index has declined but in June still registered 20%above the long-term average. Tax is a key source of uncertainty. A proposed 15%global minimum tax has gained traction and President Biden seeks to raise taxes on both domestic and foreign income. We assume a narrow version of the Biden tax plan will be passed in 2021 and take effect in 2022. Our 2022 EPS estimate of $202 (+5% growth) incorporates a $10 hit from corporate tax reform and is the primary reason our EPS estimate is below the bottom-up consensus of $212. Outside of tax, firms also face uncertainty around US-China relations, cybersecurity threats, and a potentially stricter regulatory environment for technology stocks in the US.
Yet the only way is up!
My own view is unchanged. China has killed the global reflation with credit clamps. The Fed has cremated it with a policy error. Ahead is the normalisation of the inventory super cycle, a materially slowing US, a much slower China (with nowhere enough stimulus to turn it around) and a commodity price shock.
The offsets will be European reopening, the passing of Biden stimulus and the slowly building Chinese panic turn to stimulus.
At this stage, I’m still 50/50 on a base case of stocks muddling through with support from falling yields. And a risk case of a decent stock correction as yields crash into a converging China/US slowdown.