Why "reflation" matters and how you should respond

The local market delivered a slightly negative day on weak turnover, where global passive money moves at the open and close were the only real action, despite reporting season in play. The Aussie market was aimless, as were global markets in recent days. Stretched multiples have priced most optimistic outcomes while economic, pandemic, vaccine and stimulus risks remain elevated. 

Reflation has started and is expected to gather pace over the next three to six months, while Central Banks are all talking about a no-rate-hike cycle for years to come. 

Bonds always run risk mitigation ahead of equities and that cycle has already started. US inflation met expectations overnight but the pick up is coming soon. You only have to look at the fall in USD and the rise in all commodities to see it. The US Fed was in denial as per the standard Central Bank script. 

But reality is about to bite. 

Miners and Telstra held the market from falling, while tech stocks were hit hardest today. A number of Asian markets were closed for a public holiday.

Delayed recession will meet inflation

Globally, recession has been delayed by socialism being extended to low-income groups. Socialism always existed for high income and corporates, as it’s the new augmented capitalism. 

The argument pushed by macro guys living in ivory towers is that everyone has massive savings and they will spend big to catch up. That makes sense on an aggregate level, since there hasn’t been travel/holidays and people have been locked up in their houses buying online. 

This outcome assumes that debt was not a problem, everyone kept their jobs and were in decent financial positions pre-pandemic. What we learned through the pandemic is that 40-60% of major economies are service-oriented or linked industries, with most being low paid workers who live paycheck to paycheck. 

In the real world (i.e. outside Ivory Towers), the low- to middle-income workers have very little savings. Most were affected by job losses already, or soon will be, and they work/own small service-oriented or exposed businesses. 

Put simply, the bottom half of that category of 40-60% will be in real trouble in the next six months as handouts fade. 

Similarly, the bottom third of small businesses are unlikely to return to the same scale any time soon, if at all. Governments did not extend the handouts to the low income to save them, but rather due to the lobbying from the top end to keep the economy rolling. 

Now that the top end has filled its buffers, economy-level handouts will cease in Australia and economic reality will hit the bottom end hard. 

Socialism for the top and capitalism for the bottom. What can go wrong? We are only starting QE socialism for corporates and that will continue after decades of failed trickle-down economics. But what we are ignoring is the fact that there are a lot more in the middle to low-income group than the top income group. 

We are in a deleveraging cycle and the government and RBA have handed hundreds of billions to the top end to make that happen. History has shown that spending only returns when economic recovery returns. The historical trends in deleveraging cycle do not end well with elevated economic inequality.

Time to be cautious

The reflation trade is driving the growth to value rotation. In the US, we can clearly see that via the relative performance between NASDAQ and RUSSELL. NASDAQ is loaded with tech and health care growth, while RUSSELL is dominated by local economic facing stocks. The cycle has turned and historical trend from the DotCom bubble shows that we are getting close to the period of the cycle where markets get themselves into trouble.

The optimism in the US markets has reached a 20 year high on options positioning, despite the reflation and market multiples. As with any strategy, it works till it doesn’t. Time to be cautious when the crowded trade is to chase momentum!

Options position is getting crowded. Source: Supplied.

The buybacks in the US markets jumped to substantial highs in November and has been fading since. The overall trend in the US has been insiders selling while retail punters have been buying. Time to be cautious when the insiders are selling into buybacks!

Buybacks are rising. Source: Supplied. 

The optimism in the US markets have been further elevated to higher risk though decade high growth in margin lending. Time to be cautious when leverage adds to crowded trade!

Margin lending is up. Source: Supplied.

Conclusion

Remain nimble, contrarian and cautiously pragmatic with elevated global macro risks!!! Buckle up...it’s going to get bumpy!!!

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