A month ago, I argued that, while change is on the horizon, the short-term looked benign for investors because of the scale of support provided by central banks. I make no apology for returning to this subject, with more of a focus on investor positioning. If anything, the data is becoming even more clear that, against the background of the last 15 months, the authorities are determined to err on the side of safety in generating both inflation and an economic recovery.
Central banks still have their feet to the floor almost everywhere, Australia being the major exception. Our friends at CrossBorder Capital estimate that the monetary easing last year was the equivalent of US$32 trillion, or 30% of global GDP. This year looks like adding another US$15 trillion to that total. It is hard to be negative about asset prices against the background of those numbers.
Yet investors are still generally only modestly committed compared to their long-term average. CrossBorder estimate that on a scale of -50 to +50, investor appetite for risk at the end of April was around +12, or a little above average. Adjusted for the scale of liquidity injections, it is still much nearer the bottom of its normal range than the top.
In my experience of looking at CrossBorder’s data, bull markets only come to an end when the investor appetite indicator is closer to +30, and usually occur some 9-12 months after the overall liquidity measure has peaked. As liquidity is gradually withdrawn by central banks the adjusted measure will start to rise, but it has a long way to go.
There is one contra-indicator: cross-border flows have been falling for the last year. This is surely connected to the greater difficulties of investing overseas through the COVID lockdowns, and I would expect it to reverse as economic recovery is reflected in increased global trade and investment.
Barring some political cataclysm, I am therefore even more strongly of the view that equities will continue to rise over the next six to twelve months at least. A sudden change of tack by central banks might change this, but that is currently looking very unlikely. If anything, I suggest they will respond to further COVID, or other problems, with yet more monetary easing – on the grounds that they can do that without generating significant inflation.
Which brings me on to my next point: high street inflation is going to rise this year. Last week’s US headline CPI number of 4.2% inflation may well be a blip caused by supply bottlenecks and commodity inflation. The majority of the monetary largesse will go into asset prices, as it has over the past twelve years, but as consumers are able to spend once again the accompanying fiscal easing in many countries will have more of an effect on the high street.
As I have argued previously, I see this as more of a ‘bump’ as we come out of lockdowns, and not as the beginning of a sustained rise in inflation. However, markets will undoubtedly be eyeing the inflation numbers very closely and we may see bond yields rise further than I have previously projected, perhaps to 3.0% on the U.S. 10-year Treasury.
For investors? Equities are still the default choice for most, and given investors’ positioning, we are more likely to see buying on the dip if for any reason there is a pullback in markets. So long as inflation does not breach a level of 2.5% in a sustained manner, it is unlikely to affect equity valuations. As an intriguing thought, Japan has the strongest economic momentum on the basis of the
actual-time economic indicators which CrossBorder monitor. But as I commented a month ago, that does not always translate into stock market strength, in fact, quite often the reverse.
My strongest ‘conviction’ view at the moment is that the US$ is set to fall further. It is not just the scale of overall monetary and fiscal easing under the Biden administration. At a purer and narrower level, the expansion of U.S. base money, effectively M1 together with movements in the Treasury General Account, at 20% annualised, is twice as fast as other major countries. That should lead to U.S. inflation being faster than other countries, and the U.S dollar declining correspondingly. If the effect of that is eventually to undermine its safe haven status, as happened to the British pound after its fiscal and monetary splurge during the Second World War, the falls will accelerate.
If you would like to hear more about the data behind CrossBorder’s views, please contact us here.