Road to reflation started with stimulus and likely to end with currency debasement

Local market had a negative day on low turnover as global investors were selling into AUDUSD weakness. Macro asset allocation trade from bonds to equities seems to coming to an end after Blue Wave. US 10 year bond yield is now 1.12% and above Aussie 10 year bond yield while AUDUSD has fallen from above 78 cents to below 77 cents. Energy was the only positive sector and Utilities was flat while the rest were in the red. Tech was hit the hardest while Staples, Industrials and Health Care were the next batch on the hit list. US 30 year bond yield is now delivering better yield that S&P 500 and above inflation. Reflation genie is out and the economy need stimulus. More stimulus means more inflation. The economy and the markets are like drug addicts waiting for the next hit…expect a temper tantrum if there are any delays!

US corporates have been reading the tea leaves of change in the economy for longer than markets like to give them credit. Self interest and survival are strong motivation for change. The first sign of US corporate deleveraging cycle has been triggered. After decade of money printing to provide a cheap way for them to deleverage, it was nothing short of a global pandemic recession to deliver the change. Markets will soon move from stimulus hope to higher taxes and regulations in a reflationary environment. We would expect that the deleverage cycle will start to pick up steam with reflation. US corporate growth cycle has been all about leverage and that cycle looks to be turning.

History suggests all road to reflation starts with short term stimulus boost in a crisis. The inability of the leaders of the time to deliver strong reform and evolve the economy after the recovery cycle means that it becomes an endless stimulus binge that leads to currency debasement with asset bubbles. As with all ponzi schemes, it works till it doesn’t. Everything looks good while you have strong economic growth and debt growth. Then you start to see structural economic problems drive the economy to a weak state and that leaves it susceptible to getting knocked down by a left field event like a pandemic. Sounds familiar…Japan has been there for decades, Europe is well set up for decades of grinding low growth pain while US is in denial that it has entered a reflation sandpit. The reflation sandpit is the bear trap for equity markets. The solution is simple…massive wealth redistribution and massive reform…but executing it will hurt vested interest groups and the markets in the short term. Pandemic waves, unvetted tax cuts and unvetted stimulus handouts have been like a steroid boost for inequality. “Blue Wave” political pressure will have US deliver substantial money printing to support the economy through the cycle. The fiscal reality will deliver higher tax on wall street and wealthy to pay for handout on main street. US must reflate their way out of debt and there will be winners and losers. Recent history is not a good indicator of future winners and losers in the US economic cycle!!!

US market last close > US market had another macro move from bonds to equities day to squeeze out a weak positive day. All indices started slightly positive and then fell into decent negative area as nonfarm payrolls confirmed fading recovery before pump in the last hour pulled it back to positive finish. Nonfarm was expected 50k up but was 140k down... in line with ADP data drop... that makes first negative data since pandemic started. Risk off trade mainly with bond yields, USD and NASDAQ were best...Russell and metals were negative. NASDAQ pop is driven by Baidu up 16% and Tesla up 8%. US 10 year yield above 1.1%...the bonds are better risk/return now. Trump has decided not to turn up to inauguration and Democrats are moving to impeach while Trump needs to survive to pardon a lot of people in the next few weeks. US is now getting hit hard with new pandemic variant waves as more parts of the world falls into restrictions of lockdown…even China is affected. Japan is supposedly found their own variant. Just what we need…more diversity in virus! Pandemic is going to drive short term downgrades while reflation is out and proud. Bonds long term yields are better than inflation and equity div yields.

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

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