Global Macro & Strategy

Macro Strategy Update: the narratives vs the data

As often happens in markets, there is a constant battle between the narratives and the economic data.

And more often than not, it’s the narratives that get all the attention as – lets face it – they are more interesting than the boring old data. They also make the news as they tend to be the ones that markets react to in the short term. However, over the medium to longer term, it’s the data that ultimately shapes the final outcomes.

So as investors, we need to understand how both of them affect the asset markets that we are invested in, and the timeframes that apply. The current push-pull between these two is a great example.

The Narratives:

The current narratives driving the short term positive sentiments in markets include:

  • THE BLUE WAVE IN THE US: whilst polls have been very wrong in a number of recent elections, the growing consensus of a blue wave (Democratic sweep in the US election) is driving positive sentiment in the stock market. This is based on the expectation that they would rush through a huge new stimulus package (debt be damned), better collaboration with trading partners (think China and Mexico), the general end of dysfunction in the US political process, and the unpredictability that surrounds the current administration.
  • EXPECTED BIG NEW STIMULUS IN THE US: markets seem to have given up on a new stimulus bill in the US prior to the election, but are expecting something huge after it, and are discounting this forward right now. This is obviously linked to no.1 above, and is dependent on the Democrats getting control after the US election. Markets are forward looking, and will look through the current impasse and towards the future outcome. Everyone from the IMF to the US Fed Chairman are essentially pleading with lawmakers to pass another big spending fiscal bill, and a handful of Republicans are throwing a spanner in the works. Post election, if the polls are correct (big caveat) then this wont be an issue anymore.
  • IN AUSTRALIA, THE BIG SPENDING BUDGET: whilst its the global settings that have the most impact on overall asset classes, the Federal budget can have an effect here if its big enough, and this one was big. Huge stimulus via tax cuts, business tax write offs, and other spending. Good for online retail, autos, and construction. Australia is on “full throttle stimulus”, both fiscal and monetary. This has also led to some analyst GDP upgrades, which can filter through to upgrades in analysts price targets.
  • COVID VACCINE OPTIMISM: notwithstanding the fact that the ultimate economic fallout from COVID has been less than initially feared, it has still been significant and the threat of new lockdowns as new waves have emerged though Europe and the US has kept the COVID risk alive. The flipside of this is that continual positively framed news around the progression of a COVID vaccine had also boosted sentiment, although it has to be said that this is getting long in the tooth. No doubt an actual final vaccine would be a big short term boost to markets.

Supporting all this is are the Consumer & Business Confidence measures, that all seem to have bottomed and are hooking up again.

The Data

The data that has been coming through has been absolutely supportive of this optimism, and has supported the rising tide of risk assets (stocks, commodities etc) over the past several months. PMIs are in expansion territory again, and retail sales in the US and Australia has recovered to even higher than pre-virus levels off the back of Government payments to individuals. Housing and manufacturing in the US are leading the recovery, which is good as they have the highest employment multiplier  effects in the economy. Other growth indicators like industrial production and durable goods orders are still negative year-over-year, but are trending up (i..e accelerating from low levels) and markets like positive rate-of-change in the data, even if the levels are still negative.

Sounds great. What’s the problem ?

The data that we just talked about is in the rear vision mirror. Markets front run the data, such that you will always be behind the eight ball if you wait for published economic data to confirm your position.

This is where forward looking econometric modelling comes in, and there is currently a non-insubstantial risk that as we traverse the 4th quarter this year, the year-over-year data may deliver negative rate-of-change in both the growth and inflation data. This is significant because this particular combination is the economic regime that has historically been associated with “risk off”. It tends to be accompanied with higher volatility, and is usually negative for stocks and commodities, but is positive for bonds and the US dollar. The current trend of high frequency data indicates its a very close call right now between this and the alternative stagflation setup (inflation slightly up), which tends to be better for growth stocks (especially tech) and commodities. The markets have been behaving right in line with this indecision, with weeks of risk off, then flipping to weeks of risk on. Its literally on a knifes edge and the flip flopping in many parts of the global macro markets are reflecting this.

The bottom line:

As we write this, the positive narratives are in the ascendency providing a positive market sentiment. Government policy and central bank policy have neutralised / suspended the effect of the big negative problems (such as high unemployment) for now, but will require more Government borrowing and spending (more on this for members in The Big Picture Summary).

The key risk to investment portfolios right now who are heavily weighted in risk assets is if the high frequency growth and inflation data starts to more clearly show a rising probability of the “risk off” deflation regime in Q4. If it does, we’ll provide the update.

 

Author: Graham Parkes

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