Stagflation risk rising for stimulus addicted markets

Local market started positive and faded into a mainly flat day. We have just delivered the first week with all 5 days being negative since Feb 2020 (i.e. pandemic crash). Relatively low turnover continued through the ninth week in a row without a double-digit turnover day. Size mattered as Large Caps were the best while Micro Caps were the worst. Utilities and Staples were the best sectors while Miners and Tech were the worst.

Global growth is in downgrade cycle and that is happening in all parts of the world. China and EU have been downgrading while Emerging Markets have been in downgrade for a while. US has joined the downgrade cycle in recent weeks. Australia is joining the band wagon with commodities and currency in free fall. Inflation in most of the major regions are expected to outpace the growth outlook by Q4. Stagflation risk is real and rising.

Market are currently worried about QE tapering risk in the US. US Fed hitched their tapering cycle to employment market and away from inflation. US Fed is now facing historic high inflation and best employment conditions since the pandemic. They should be moving to tapering but they are likely to talk a lot and do very little. Very similar to RBA, US Fed will just buy time for the stagflation to take effect and then use that as the reason to keep QE going forever. It will buy time for asset bubbles but inevitably that will continue to suffocate the economy into lower and lower growth over time. Jackson Hole symposium next week will confirm that US Fed will do nothing much at all. Markets are forward looking and it will soon move to price in the lower growth outlook. It may be different this time!

Majority of the bigger Central Banks of the West are motivated to support asset bubbles over the economy by keeping rates and QE as status quo due to excessive debt loading. But that is not the case for Emerging Economies and smaller Developed Economies. They are moving to curb QE and raise rates to attract capital. The rising capital wars are going to debase the currencies of the lazy Western economies sitting on substantial debt and low rates. Debasing currencies are going to exaggerate the inflationary pressure in the future. This will feed into the stagflation worries even more than before. It may be different this time!

Middle East uncertainty to further provide fertile ground for China to grow their economic expansion. Afghanistan has fallen quicker than expected like what we saw in Iraq war. Just for context about the Afghan force…(1) low paid force in a fractured country (2) they were expected to fall in a few months anyway (3) leadership left the scene as fast as the Western forces left (4) major cities were falling by the day and it looked inevitable (5) long history of failed super powers. No force facing imminent death is likely to hang around without strong leadership linked by religion or patriotism. China has already made it’s move to bring the new Afghanistan into their economic fold. Russia and Iran will stand on the sidelines to get their piece. Middle East over time likely to become another China hub like Asia, Africa and South America.

Australian economy is going into negative Q3 with a real risk of negative Q4. NSW has mainly lost control of the delta cluster and we are likely to see new waves in East and North in the next few months. NSW has started to copy part of the VIC strategy while ignoring other parts to make it look different. The NSW cluster has now spreading through VIC and NZ. VIC and NZ already have tougher lockdown than NSW and they are struggling. Parts of NSW is likely to be in restriction well into October. Federal election in Q1 is likely to attract government handout and QE expansion by RBA in Nov/Dec. There is no taper in sight. It may be different this time!

Seasonal cycles suggest the US market peaks this week as macro risks become the main play. US and Australian markets are about to have the monthly option/futures expiry and historical trend suggest weakness follows.

Let us run through the main data points released in the last 24 hours…

Canada added 221,300 jobs from June to July of 2021, according to the ADP Canada National Employment Report. Employment rose primarily in services, namely trade & transportation and utilities (+56,900), leisure and hospitality (+64,300) and health care (+28,400).

The number of Americans filing new claims for unemployment benefits fell for a fourth straight period to a new pandemic low of 348 thousand in the week ending August 14th, below market expectations of 363 thousand and signaling a continued recovery in the US labor market even as many US states struggle to contain rising coronavirus cases amid the spread of the Delta variant. Still, new weekly claims remained elevated compared with an average of 200 thousand seen before the pandemic. The total number of claimants is likely to decline further in the coming weeks as more states end federal unemployment benefits ahead of their official September expiration date at the national level.

The Philadelphia Fed Manufacturing Index in the US continued to fall for a 4th straight month to 19.4 in August of 2021, below forecasts of 23, and reaching a new low since December of 2020. Manufacturing activity in the Philadelphia region continued to grow but current indicators for general activity and shipments declined from July’s readings but remained elevated, while the new orders indicator rose. Additionally, employment increases were more widespread this month, and both price indexes remained elevated. Most future indexes moderated this month but continue to indicate that the firms expect growth over the next six months.

Japan's consumer prices declined by 0.3% yoy in July 2021, after a revised 0.5% drop a month earlier. This was the tenth straight month of decrease in consumer prices, amid weakening consumption due to the ongoing COVID-19 pandemic. Cost fell further for both transportation & communication (-5.4% vs -5.4%) and medical care (-0.5% vs -0.6%). At the same time, food prices fell 0.6%, compared to a revised flat reading in June. In contrast, there were rises in cost of housing (0.6% vs 0.6%), fuel, light and water charges (2.2% vs 1%), furniture and household utensils (2.4% vs 1.6%), culture & recreation (1.9% vs flat reading), education (1.1% vs 1.4%), and miscellaneous (1.2% vs 1%). Core consumer prices, which exclude fresh food, dropped 0.2% yoy, the 12th straight month of fall and compared with market consensus of a 0.4% decline. On a monthly basis, consumer prices went up 0.2% following a downwardly revised 0.1% rise in June.

Comments on US market last close…

US market started negative and finished mainly flat on late pump in tech stocks. RUSSELL -1.22%, DOW -0.19%, NASDAQ +0.11% and S&P +0.13%. VIX ticked up but stayed below 22. Yields were lower while USD moved higher. Commodities were lower while Gold was mainly flat. AUDUSD is on a free fall like Iron Ore. Tech and Property were the best sectors while Energy and Materials were the worst. Weekly jobless data keeps improving better than expected while White House moved to cancel student debt for disability groups. The rest of the students are waiting for the debt to be cut as well.

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