Global Macro & Strategy

The data, the spin, and the reflation regime

It is amazing how convoluted the market narratives can get. When the market is determined to be bullish no matter what, then any event can be construed as positive, even if the same possible event was construed as negative just a couple of months before.

Lets take the US Senate runoff elections this past week. Back in November, the US Presidential election saw Joe Biden win the Presidential race, however it appeared at the time that the Republicans would hold on to a slim majority in the Senate. This notion of further political gridlock meant that some of the more contentious of Joe Biden’s policies, such as corporate tax hikes and increased regulations, would likely be non-starters given the Republicans opposition to them. Hence, it was widely reported that investors were happy with this “split” result, and the markets rallied strongly (albeit the vaccine news around that time was also a strong catalyst).

Fast forward to this past week where the Democrats have in fact swept the race by winning both runoff seats, and hence now have power in both houses, and the market now has a different spin on things. As I wrote last week on this issue:

“Now whilst the Democratic sweep may sound negative, its also very plausible in this “we’ll spin anything as good news” market that a Democratic sweep will be interpreted as a higher probability of additional fiscal stimulus, with the resultant increase in inflation expectations.”

That’s pretty much exactly how its played out. News outlets are awash with positive stories on how the Democratic sweep will provide brighter days for Main Street and a higher expected fiscal stimulus impulse. The US stock market indices have jumped to all time highs, with not even the debacle of Trump supporters storming the US Capitol derailing the “risk on” rally. Inflation expectations have also jumped, as has the important benchmark US 10 year yield jumping above 1.1% and staying there thus far.

The data determines the spin

Whilst most investors focus on the news and the narratives, as we’ve just seen, these very same narratives can be little more than a convenient exercise in trying to explain what is going on, even if it contradicts itself from not-so-long-ago.

The reality is that the data determines the narratives. What we mean by that is the market reacts in real time to the myriad of high frequency data that is being constantly fed into it, and the narratives are then formed around whatever events are happening at that time to try and explain it. After all, that’s a lot simpler than trying to explain the net affect of a ton of data!  Given many events have two sides to them – in other words, they can be spun as either positive or negative, such as the example we gave above around the US Senate runoffs – then you can see how tenuous it can be to run your investment portfolio based on the financial news and narratives of the day. The most important point to focus on as investors is the data. Where it’s come from, where it is now, and where is it likely going, and are the markets across global macro agreeing with your assessment.

To put it simply, if the myriad of high frequency growth and inflation data points are decelerating, then risk is rising and news events will be spun as negative. Conversely, if those same growth and inflation data points are accelerating (like now), then news events will be spun as positive – and negative external issues will simply be dismissed. It really does get that simple sometimes, so its important as investors to be aware of that and be aware of where we actually are from a fundamental perspective.

You’ll often hear me talk about the “economic regime” we are in, and which one we are likely heading to in the next quarter or two. This process uses quantitative modelling to aggregate the most important growth and inflation data that are relevant to financial markets, and provide us with a road map for where we are now and where we are likely heading. We then look at what the global asset markets are actually doing to provide confirmation. This process helps get the direction right across asset classes and helps identify where the pockets of risk are.

It’s called Reflation

Right now, we are right smack in the midst of a “reflation” economic regime across most of the world. This is very much the “risk on” regime, which has historically been positive for risk assets such as shares and commodities, with the later feeding into inflation, which then feeds into higher longer term interest rates (i.e the 10 year bond rates). Rising rates tends to be negative for bond prices, and the US dollar tends to also be weak. Conversely commodity currencies such as the Aussie dollar strengthen. The strength in copper and weaker US dollar also correlates strongly with strength in Emerging markets shares.

If you look at the recent trends on the Portfolio Strategy update charts, you’ll see this is exactly how markets have been behaving, hence confirming the Reflation economic regime of the economic modelling process. The forward looking modelling has the reflation regime continuing for the first half of this year, with a possible pivot in Q3. The market will often font run these pivots, so it won’t be plain sailing. It never is.

However for now, this fundamentally positive economic regime, combined with the largesse of monetary and fiscal policy stimulus provides a positive backdrop for share portfolios (or share funds) and commodities, whilst the rising rates environment will be a headwind for bonds and gold.

The wildcard of course continues to be COVID. The market is looking through the current problems towards a vaccinated future. If anything happens to derail that (i.e. a new variant whereby the vaccine is ineffective) then we get an entirely different ball game. But until then…….


Author: Graham Parkes

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