Equity and Risk Markets: The Song Remains the Same

Summary

• Markets have pricked asset bubbles. It is hard to see any super-inflated public market pricing.
• Expect the US inflation bump to be transitory, US job gains to hit 1mn+ per month, and reopenings to continue.
• The song remains the same; higher rates are a good thing. The US recovery is baked in – China’s too – but watch Europe.

Market Implications

• Bullish risk assets, especially given positive seasonals ahead and bubble pricking behind.

Markets have pricked asset bubbles, be they in stocks or bonds. And surveying the landscape, it is hard to see any super-inflated public market pricing. FANGS, Robinhood bros, clean energy/ARK names, and mispriced USTs – we had a rolling series of corrections. The Archegos affair is just the icing on the cake.

The result? Stocks at all-time highs, the VIX Index under 20, and the worst quarter for long-duration UST in decades (no surprise here). It is impressive. One of my prime rules is to let the market tell me, not vice versa. The market was speaking loudly last week with the launch of President Biden’s American Jobs Plan, its $2.5tn price tag, and a much-better-than-expected March jobs report. What did the 10-year UST do? It rallied. What does that tell us? That it is in the price.

Now is test time for higher inflation prints. The short period of 4%+ numbers, whether in China or US PPI and coming to US headline CPI, is here. And it will remain for a few months as the negative numbers from last year’s Covid cessation roll off the YoY comparisons.

Would it not be perfect for UST to rally? Yes, rally into this period. Some folks think this is likely, coming together with re-openings and earnings to spur a Nasdaq-led melt up in stocks. It was plausible enough for me to consider when doing my monthly model portfolio review this past week.

This model portfolio review process is always interesting. It is where the rubber meets the road, so to speak. I have two observations to share. First, I looked not only at YTD performance but also performance back to 31 December 2019 to avoid the March-March Covid comparison. I found that fully half of the current portfolio is either down or up less than 10% over the past 15 months vs up 20% for the MSCI ACWI Index. That suggests some good potential upside. 

Second, worried about the UST rally and Nasdaq-led melt-up scenario, I explored how much the thematic slice of the portfolio, some 20%+, would help in that instance. A YTD correlation analysis of the two yields a correlation of .68, implying some protection there to accompany the model’s heavy value tilt, both US sector and non-US equity overweight.

The song remains the same. Higher rates are a good thing. Expect surging EPS, though much is expected here. FactSet reports Q1 as the biggest US EPS increase since 2002 led by value sectors. Do not invest on headlines. Europe seems like a disaster with vaccinations fumbles and lockdowns galore, but record Manufacturing PMI and a Composite PMI at 53 says otherwise. So do the equity markets, with EuroStoxx 600 up five weeks in a row and down only three weeks since December. Yet the US-EAFE valuation gap remains extreme.

In the near future, expect the US inflation bump to be transitory, US job gains to hit 1mn+ per month (they are still 11mn short in the US, while EU unemployment rate at 8% has room to improve), re-openings to continue, and Biden’s Jobs Plan to pass à la the Rescue Plan (both very popular across the aisle).

The US recovery is baked in – China’s, too – but watch Europe. Expect the divergences between the EU and US in the vaccination process and economic activity to start narrowing, supporting the euro and leading to USD rollover and an EM FX bounce. Keep calm over China credit concerns – still targeting 11% YoY loan growth. 

On the thematic front, crypto news continues to pour in: $2tn in assets, Grayscale Bitcoin Trust (GBTC) to convert to an ETF, and Coinbase to list next week. Great to see JPMorgan CEO Jamie Dimon jump aboard the fintech train; I am very focused on the melding of banks, fintech and crypto.

Watch for carbon to be a big part of the upcoming US climate summit. It was virtually ignored in the Jobs Plan rollout. Expect carbon permit pricing to move sharply higher in coming quarters/years as companies come under pressure to publicize their carbon footprint and consequently seek offsets. The interplay between the Georgia voting law and employee, customer, and shareholder pressure for corporate response represents the template.

Bottom line

The risk/reward of investing in risk assets such as equities is appealing, especially given positive seasonals ahead and bubble pricking behind.