The smartest guys in the room are as undiversified this week as always. Stagflation is the mem dejour with BofA still leading that pack:
H2 view: macro backdrop = higher inflation, hawkish central banks, weaker growth, i.e.stagflationary; investment backdrop = rising Rates,Regulation, Redistribution (3Rs–Chart 6) & peak Positioning, Policy, Profits (3Ps); investment returns = low/negativestock/credit H2; optimal portfolio = H2 barbell oflong inflation (e.g. commodities, TIPS,small cap, banks, Japan) & long quality (e.g. cash & defensive utilities, staples, healthcare, REITs).
Peak policy: monetary policy driving absolute returns, fiscal policy driving relative returns; note pace of CB bond purchases decelerating from $8.5tn in ’20 to $2.3tn in ’21,and then to $0.3tn in ’22 (Chart 7).
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Investing for Stagflation: important to note 3 stagflation phases during mid-60s tolate-70s; we believe we are in phase 1 with phase 2 starting in 2022…
1.1965-68…inflation & interest rates breakout to upside from multi-year ranges, stockmarket peaks, but “stagflation”neither visible nor anticipated…equities outperformed via a“barbell”of small cap value and Nifty 50 tech outperform (Chart8);
2.1969-73…end of Bretton Woods & oil shock causes sharp risein inflation ending Nifty-50 bull market & kick-starting volatility & commodity bulls (Chart 9);
3.1974-81…inflation & real assets outperform all asset classes (Chart 10)
I still don’t buy this “stagflation” scenario. Not when China is going to tighten directly into western stimulus and the inventory cycle wind down. So, commods remain a no go zone for me. I agree with staples, however, given China is killing the global credit cycle and Fed is about to cremate the corpse.
JPM is outright bullish on everything:
Cross-Asset Strategy:We retain a pro-risk allocation on strong global growth as the world continues to recover from the pandemic, accommodative policy, and continuing earnings surprises. Reopening of the global economy was delayed by the delta variant spread, but the delta wave is likey receding in the US and globally, and the pandemic recovery should restart (Rt is falling and below one in~90% of US states,infections are dropping in 40 states, and global cases are falling for the past 2 weeks–e.g., see here). As delta subsides, and inflation persists due to supply frictions from reopening and accommodative monetary policy, we expect the reflation/reopening trade to resume its outperformance and believe that bond yields and cyclicals likely bottomed early last month. We therefore keep large OWs in equities (tilted towards value and cyclical segments) and commodities, funded by an UW in bonds. Regionally, we implement our preference for cyclicals/value via an OW in EM, Japan and Europe vs. the US, and we increase our OWs in EM and Japan this month given their recent underperformance and an anticipated boost in Japan fro m political regime change.
I have softened my view on energy. China is short of coal and Europe is short of gas so it’s going to time to resolve those two. That may offer some support for oil at the margin. That throws up a longer tail on inflation and some value trades.
However, the fly in the petroleum jelly remains China. The hard landing unfolding in its construction sectors will hit energy too. The issues for coal and gas are apparent market balances not underlying so they will resolve in time.
Therefore, I am still not convinced that it will be enough to sustain inflation as the China and US slowdowns converge into 2022. I remain bearish commods and EM.
Goldman is probably making the most sense to me this week:
Investors have expressed concern about what the recently reduced economic growth outlook means for equities, particularly because GDP downgrades since the start of 3Q have contrasted with positive earnings and sales revisions. Although at the index level the S&P 500 tradesjust2%below its record high set last week, for months, performance within the equity market has reflected the weakening economic environment. Congress plans to raise corporate taxes to fund reconciliation legislation. However, the stock market is only partially pricing an increased tax rate in2022. In the uncertain economic and tax policy environment, stocks with stable earnings and strong balance sheets should continue to outperform.
Earnings revisions usually carry a particularly strong signal for stock returns in the current stage of the business cycle, underscoring the importance of these catalysts. Since 1990, our sector-neutral EPS Revisions factor has posted its strongest average return when the ISM was above 50 but declining from its peak. This dynamic suggests opportunity for fundamental equity investors who identify companies with earnings outlooks that will remain strong despite a shifting economic and political landscape. The market already appears to be focusing on quality companies with stable earnings; since the start of June, high pricing power stocks have outperformed low pricing power stocks by 11 pp, and our Quality basket(GSTHQUAL) has outperformed the S&P 500 by5pp. See Ex.5for constituents.
I would simply add that the risk of a headline-level stock correction risk is high as China kills the global credit impulse and the Fed cremates the corpse with taper.
We retain a conservative equity allocation weighted to Defensive Quality and Quality Growth, market-weight bonds and long USD.