Reflation remains in play
Australian Market Strategist
Summary: We recap drivers of todays trading session, Yellens testimony and the stimulus focus of the incoming administration and touch upon our preferred overweight Asia.
The ongoing reflation trade fuelled ahead of Yellen’s testimony has set the tone for the week’s trading activity – Commodities pushing higher alongside Asian equities and a weaker USD. All-time highs for US indices, the small cap Russell 200, S&P 500 and the NASDAQ. The NASDAQ soaring as Netflix delivered a beat on subscriber growth - 8.5mn in the final quarter of 2020, well ahead of expectations. Lockdowns across Europe likely helping alongside several big hits in the content library boosting performance.
US equities pushed higher as President Joe Biden was sworn in, anticipation of more stimulus, more spending, more borrowing with the incoming Yellen, Powell tag team. Along with a dose of dealer gamma perpetuating the virtuous feedback loop higher as market makers a forced to buy equities.
Focus Inequality - The US dollar remaining under pressure following confirmation of the Yellen Treasury MMT-lite shift. A long awaited realisation that monetary policy cannot fix the structural issues weighing on potential growth in many developed economies. In fact, it exacerbates one of the most precipitous issues – ever-growing wealth concentration and a deeply polarising, uneven recovery from the COVID-19 crisis. This is in many ways, the evolution of central banking, the former Fed Chair at the helm of Treasury – a big step toward fiscal primacy and the merging of the two functions.
Yellen has been spruiking the “living wage” argument, pointing to the K-shaped economy and has her sights firmly set on the labour market. A fiscal push aimed at maintaining income/demand in a more evenly distributed fashion and expanding the social safety net - More money straight to the pockets of those with the highest propensity to consume. This regime shift for fiscal, combined with supply side pressures, will be a perfect storm for higher inflation.
These policy shifts, continuing to support our expectation of a weaker USD and positive views on emerging markets, commodities and higher inflation and higher long dated yields, yields globally have likely seen their lows. For now, the Fed seem happy to let longer dated yields climb (likely until this becomes a pain point for asset markets).
As we wrote back in November, this set up is favourable for non-US markets, Asia in particular a beneficiary of the ongoing rotation and shift in market leadership accompanying these policy changes afoot – we flagged South Korea, Japan, China, Taiwan as opportunities within the broad Asia region in. Asian outperformance has been driven by an increased delta to the vaccine rollout and recovery story, which is where investors have focussed since the back end of 2020. Asia also benefitting from better virus handling, the engine of China’s reflationary regime with broad scale infrastructure and construction stimulus, and continued dollar weakness, supporting flows into higher beta emerging markets. This is still the case, although following the bout of outperformance we would not be surprised to see a corrective move in the near term – a good place to re-establish longs.
Another flag in November, was the trifecta of support measures in place for Australian stocks to break higher. The resource heavy nature of the index and heavy weighting toward financials should continue to support performance throughout 1Q21. As we transition toward an inflationary regime, with a synchronised global growth reacceleration, coupled with unprecedented liquidity injections against the backdrop of extraordinary fiscal stimulus, we continue to see a shift in market leadership toward cyclical sectors and geographies, real economy stocks, non-US markets and commodities. Also flagged in November - (industrials, materials, miners, travel and leisure, energy etc., emerging markets - favoured EWZ, EWW, THD, small caps - IWM). Therefore, the more cyclically orientated nature of the ASX 200 should support index performance as the reflation rotation continues.