Morgan Stanley says its a boom:
Our US cycle indicator skips the ‘recovery’ phase and switches straight to ‘expansion’. Historically, this has supported owning equities and driven important changes in leadership.
Our cycle model switches to ‘expansion’: Big moves in consumer confidence and initial jobless claims mean that data which drive our cycle indicator are now ‘better than average and improving’, moving the model from ‘repair’ to ‘expansion’, jumping swiftly past the ‘recovery’ phase that tends to lie between the two. We see this as support for our case for a hotter but shorter cycle.
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‘Expansion’ means a positive environment for DM equities and challenging backdrop for fixed income: Historically, ‘expansion’ has seen the strongest returns for DM equities even as EM stocks lag. Fixed income returns suffer as yields rise in early ‘expansion’ and credit spreads widen in late ‘expansion’, with UST 10Y and HY hit hardest. USD strengthens after underperformance in early-cycle.
Factors in ‘expansions’–keep calm and carry on: Carry is the overwhelmingly strong performer across assets in this part of the cycle. ‘Expansion’ is also characterised by low realised volatility, consistent with the strong performance of carry.
Strategy implications–move to UW government bonds: Optimal asset allocation in ‘expansions’ typically means favouring stocks over fixed income. In particular, DM equities tend to see an increased weighting compared to early-cycle, while UST 10Y and USHY see large decreases in allocation. We recommend moving UW on government bonds via paring back UST exposure, and add an outright short in UST 10y to our top trades portfolio.
Readers of this weekly update may recall that another MS strategist has been calling for material “mid-cycle” correction. There’s nothing like having a bet each way!
JPMorgan is still bullish:
Reopening plays already discount lower mobility and should regain leadership in 2H21.We think reopening plays could start to do better again, after losing ground in both the US and Europe the last three months, supported by above-trend 2H growth and strong consumer fundamentals. Investor nervousness is high at present over the Delta variant and how policymakers will deal with it, but this might end up an opportunity to add to the reopening theme again. Within the J.P.Morgan call of above-trend growth in 2H and beyond, the consumer plays a central role. It sports strong balance sheets with elevated savings rates, positive wealth effects, and crucially, labor markets are continuing to improve. The Delta variant is a key risk to the call, but encouragingly the link between the case count and hospitalizations/deaths in the UK and other countries has weakened meaningfully. Policymakers might end up adopting a different approach to tackling the pandemic, rather than reverting to strict mobility restrictions. Even if the restrictions return, this might not be much of a surprise to the market, as reopening plays have lagged significantly, in effect already discounting lower mobility. Finally, the earnings hurdle rate is far from demanding, where consensus projects that consumer reopening plays’ ‘22 EPS will still be as much as 30% below pre-COVID-19 levels, in contrast to the broader market that will be ahead by 15%.
This makes no sense. If the reopening trade continues, then so does Fed tapering and a strong DXY. If so, the last place you want to be is EM and commodities.
Goldman is always bullish:
In the wake of almost 18 months of pandemic-driven curtailed activity, Sid Bhushan and Daan Struyven estimate that households have accumulated $5tn in excess savings globally, led by the US, Canada, and the UK, in“The Boost From Pent-Up Savings.” We also estimate that ~90% of excess savings across developed markets are held in liquid currency and deposits. The growth boost from running down these ‘excess’ savings in large economies should help to offset the headwinds from renewed waves of the virus, uncertainty about US fiscal stimulus, and China growth concerns. We estimate: n14% of excess savings will be spent within a year of reopening; na boost to the level of global GDP by a peak of 1% in mid-2022 and annualized global growth by 1¼pp at the start of next year before turning negative in the back-end of 2022; and the boost to annualized growth is much larger in advanced economies, peaking at 2pp by the end of 2021, than the ½pp boost early next year in emerging markets. Overall, we continue to forecast global GDP growth of 6.5% in 2021 and 4.8% in2022.
Other strategists have turned markedly bearish. BofA has been the outstanding bear this year, so far wrongly:
Bull case in 12 words: “We don’t know…Fed don’t know…Fed don’t tighten…market go up”; bull case is ambiguity (of macro, payroll, inflation, fiscal) = liquidity.
Bear case in 15 words: “Pandemic, Price, Positioning, Policy, Profits = -ve Q4 GDP = -ve Q3 credit & stocks”; Q3 recommendation is IG over HY, defensives over tech & cyclicals, small cap to be cyclical lead indicator, commodities as inflation hedge, best‘21/’22 stagflation AA 25/25/25/25 bond/stock/cash/commodities.
…Boom…bust: China slowing, PMIs & EPS peaking, biggest H2 surprise is peak US consumer (inflation, lagging labor recovery, end of artificial stimulants cause savings ratio to remain high); plus Wall St leads Main St so re-pricing lower of overvalued stocks& credit will lead to drop in business & consumer confidence.
Tightening…flattening: NZ ending QE Jul 23rd(Chart 13), Canada ending QE Oct 27th, house prices surging 15-20% (Chart 12) & yield curve collapsing in both countries; global tapering underway UK, Australia, Sweden…25 global rate hikes YTD vs 11 cuts; global yield curves mimicking “bond conundrum” years of 2006/7 when ultimately long-end correctly smelt a rat.
That nicely sums up my 50% risk case for H2 except for the crazy belief that commodity prices will be the only asset class not to correct!
Deutsche is the pick. Both bearish and bullish:
Mind the gap. Many would argue that there is a linear continuity in the global economic reopening throughout the year. We don’t agree. It is better to look at 2021 in two discrete phases. The first half has been marked by truly unprecedented pro-cyclical government intervention: an immense fiscal stimulus led by the US, a lifting of restrictions on activity, and a massive vaccine roll-out program. This unprecedented mix generated the “gangbusters” recovery narrative of H1. But the second half of the year will be completely different: fiscal support is being withdrawn across the globe; the initial burst of activity in a return to “normal” is complete; and the G3 vaccine roll-out has run its course. The next few months will be all about the hand-off in growth drivers to the private sector. It is this period that is crucial to understanding what the “new normal” will look like; we should be very cautious in projecting the H1 macro story to H2, and it is precisely this caution that the market has been pricing in recent weeks.
What have we learnt so far? As this handover has started to take place, we have learnt a few important things, which have leaned negative. First, bottlenecks and price increases have caused greater demand destruction than one would have assumed. This can be seen in the sharp slowing in US housing and global auto demand, for example; or in consumer surveys, which show intention to buy goods because of rising prices as collapsing, rather than accelerating like the 1970s. Put differently, the impact of price increases has been more stagflationary rather than inflationary. Second, we are seeing tentative signs that consumer spending is not as boomy as one would have thought. We first noticed the pattern in Israel a few months ago. But you are also now seeing it in the UK where credit card spending in June is below what it was in May, and in the US where consumer spending forecasts for late Q2 are being brought down. Third, we have learnt that vaccines are not a panacea. The new delta variant mechanically brings herd immunity out of reach due to much higher transmissibility. But crucially we are seeing that vaccination rates tend to stall at around 60% of the population, with the stalling in the US the most noticeable. Fourth, we have learnt that the Chinacycle is very different from that in 2008-10, with the risks already shifting to monetary easing and much less structural support for the commodity supercycle compared to the previous global recovery. All of these are important developments that took the steam out of the reflation trade in Q2.
The trillion dollar question. The reflation debate is not about fiscal policy. It is about how much of the excess savings generated from fiscal policy will be spent, ie the private sector’s marginal propensity to consume. While there are reasons for optimism, there are reasons for caution too. First, empirical evidence shows that pandemics historically lead to very large increases in the precautionary savings motive, equivalent to r* declines of 150-200bps. The question therefore is not whether the fiscal stimulus we have seen is big, but whether it is large enough too ffset such huge declines in real neutral rates. The temporary nature of the stimulus augurs for caution. Beyond the impact of the US mid-terms on American fisca lpolicy, it is notable for example that the UK fiscal debate is already shifting to significantly more tightening. Second, recoveries from services recessions have historically tended to be more mediocre. There are a limit to how many restaurant meals someone can catch up on. This is a two-speed economy with a booming/overheated goods sector and a yet-to-heal services sector, and it is the latter we should be focused on. Third, aside from the cyclical drivers, we cannot overlook the huge structural change that COVID has created. The digitalization of goods distribution and the workplace would have normally taken decades to materialize. Time will tell what the impact will be, but experience of the last decade has shown that technology has historically been disinflationary. Finally, the global economy cannot be ignored because inflation and real neutral rates have been globally co-determined over the last decade. EM output gaps are projected to stay large for the foreseeable future; the fiscal overshoot in the rest of the world is much smaller than in the US. The market has flip-flopped between “gangbusters” pricing in Q1 to amore pessimistic view on r* driven by all of the above. Whatever the new steady state, watch the consumer in H2. It all boils down to how much he or she is willing to spend in the new post-COVID steady state.
The dollar outlook. We were wrong about our weaker dollar call over the summer. But we have gained confidence in the validity of our framework: what matters most for the USD is not long-end yields but Fed lift-off and front-end rates; this is why we changed view right after the June FOMC meeting. By reducing its commitment to the “transitory” inflation narrative, the Fed weakened implicit calendar-based guidance and has allowed the market to price in greater rate hikes in coming years. If market pricing is correct and the Fed lifts off in 2022, we will revert to a pre-COVIDworld of exceptionally flat curves and a strong USD. In a low r* world even small changes to rates attract large (unhedged) inflows similar to the 2015-19 period:EUR/USD could drop all the way back down to 1.10. Ultimately though, it boils down to what regime we are in: if, in contrast, the back end of the curve is correct in its growth and inflation pessimism, it is unlikely that Fed hikes get realized and we revert to a weaker dollar. We agree with our house view of delayed/slow lift-off, so our bias is for a weaker dollar to eventually return.
That’s right in the MB Fund wheelhouse of 50/50 base and risk cases for ongoing gains versus a material correction. It’s a deflationary backdrop with the timing of stimulus for shorter-term reflations determined by policy intervention. Timing these will determine performance versus the market.
Presently, China credit clamps have killed the global relation and the Fed’s hawkish pivot is cremating the corpse. But will growth fade enough to force asset prices lower or will policymakers panic hard and early and drive them higher still?