Reflation could be the great bubble buster that cures the world of asset bubble addiction

Local market flip-flopped all day before finishing slightly in the red. It would have been worse if the miners weren’t bucking the trend of rising commodity prices. It was all about reflation. We have been talking about reflation since mid-2020 and it seems the market is finally waking up to the problem. As usual, the herd is late to the game while the bond market has driven the yields from 60bps low at peak of the Global Pandemic Crisis (GPC) to 160bps now. In comparative terms, that is like four rate hikes by RBA. The simple maths is that the asset prices fall as the risk-free rate rises. 

The best performing sectors of recent years have clearly been tech and health care, where the best-performing stocks won’t make a profit for years to come. Dreams are cheap when the cost of borrowing keeps falling. On the flip side, high growth stocks in a low growth environment deserve the higher multiple as they are the one-eyed man in the land of the blind. The reality of reflation has started to bite the market and the high growth stocks were leading the falls with mining the only green sector. High growth stocks will still be high growth stocks but the multiples will be far lower. In the macro panic, few small/micro-caps were being pumped for a month-end performance boost by some major shareholders. Will the market panic on reflation? Will it mean revert some of the recent exuberance? Will the USD and bonds run with gold while equities pullback? Time will tell.

Dreams are cheap when the cost of borrowing keeps falling.

It is clear that US Fed is not going to step up and burn its balance sheet to hold back bond yields until it goes into hyperinflation. The White House has clearly shown their policy preference is to take on stagflation risk over recession risk. Republicans may play hardball but they won’t win mid-term elections by holding back stimulus. Democrats were not elected to support the market. Low growth, high inflation and elevated unemployment is the outlook for US economy and that will attract elevated stimulus. More stimulus means more USD debasement and that will make inflation even greater. 

More stimulus means more USD debasement and that will make inflation even greater.

The next level of USD debasement will jam up all other currencies like EUR, YEN and AUD. It was obvious and deliberate. The RBA has lost control of the currency and the bond yields. Australia is not even in the same league as US when it comes to a currency war. The RBA can do QE, but it’s a candle in the global QE snowstorm. Everything is a zero-sum game. The RBA has taken future returns from retirees/savers and handed it over to corporates, while the Australian government has done the same with the JobKeeper program. It’s sold as socialism to help the majority but it digs a deeper hole in the future. 

Reflation could be the great bubble buster that cures the world of asset bubble addiction. The US is moving to pop bubbles and reform to save its economy in the long term. Australia is sitting on multiple bubbles. They were created intentionally by the government and RBA to helps certain parts of the economy with a view of a multiplier effect and trickle-down economics. As usual, it delivers a short term boost and leaves a mess to clean up in the long term. Can we follow the US and do reform to save the economy? Or keep feeding zombie companies to keep the bubble going for a bit longer? History suggests we will make the wrong, lazy choice again. The RBA has already lost control of the currency and asset bubbles are probably next.

Comments on US market last close 

US market started positive on US Treasury Secretary Yellen's call for more stimulus and then faded all day to close flat. Bond yields are on the march higher...10-year at 1.34% and 30-year at 2.14%... reflation is hitting the market on the face and it’s confused. Copper is on a rip as with most commodities. Oil starting to slide as US frozen states thaw out. The USD is sliding again and now has pushed the pound over 1.4 level - that’s a multi-year high. RUSSELL was the massive outperformer with resources and financials being the best sectors while utilities, staples and health care were the worst. The economy needs stimulus and market can’t absorb a tax hike. The market wants to eat the cake and have it too. Reflation is going to force the Whitehouse to choose stagflation over recession. Pre-pandemic peak happened exactly 12 months ago. Something has to give and politicians will move to socialism for their survival and tax hikes look inevitable.

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

End of day market stats are on the attached link/pdf.