Because silent inflation could soon peep out
Disinflation has been the beneficial protagonist of these 40 years. It is now possible (and indeed likely) that inflation will start to rise in the coming months. The analysis by Alessandro Fugnoli, chief strategist of the Kairos funds
Like a cork in water, the stock market quickly returns to the surface whenever a threat pushes it down. The rebellion of the forums has also been reabsorbed. Overall, the wallstreetbets movement inflicted a few tens of billions in losses on a small number of hedge funds and pocketed, apart from the newcomers, a fair amount of money. But its virulence has been tempered not only for this round, but also for the next period.
As long as it aimed its still modest ammunition at small and well-chosen targets (such as short positions on small companies for even more than the issued bonds) it was effective. When he fell for the temptation to raise his sights on larger targets, such as silver or the Vix, his firepower revealed its limits. The financial establishment, for its part, closed the ranks while the regulators were enough to throw a few grains of sand into the gear (raising the margins to be deposited for leveraged operations) to take away the momentum of a push that was already starting to lose force on its own.
However, something will remain of this movement. Its technical ability, in some of its components, is not inferior to that of institutional investors and its ability to resist infiltrations has so far been greater than expected. In fact, in the forums there is a sort of hierarchy of both merit and seniority of presence. The millions of newcomers (4 million in a single week) are not followed immediately and must earn their influence on the field, with repeated correct advice.
The rapid recovery of the market after the initial shock and the fears of systemic effects has again demonstrated the validity of the principle that financial crises (real or, as in this case, feared) that occur in a context of cyclical recovery are always a ' purchase opportunity and not a sign of a possible trend reversal. We often complain of the fact that fundamentals are set aside and overwhelmed by a speculation that only follows the trend and then they are forgotten when episodes of financial crisis have in the background, as is the case today, two of the most fundamental powerful and positive for all, a strong cyclical recovery on the way and a monetary policy that has never been so favorable.
The other fundamental decisive, the pandemic, is also sending generally encouraging messages. Vaccines are multiplying and, where they are introduced on a large scale, the rates of spread of the disease begin to change. Of course, there is no linearity that was naively imagined a few months ago and there are variations, organizational complications and confusion, but the positive trend begins to emerge with some clarity.
Part of the market is understandably held back by valuations. It is difficult to reconcile the idea, proposed by many analysts, of a rise still in its infancy, with valuations (even normalized for Covid) that appear so high. If we start from this height, how dangerous will it be to stay run over when the levels are even higher? Don't we risk yet another crash at some point?
The answer to this legitimate objection is that the bull market that could continue until the middle of the decade does not necessarily have the same size as those that preceded it in past decades. The rise of the 2000s in New York brought the index from 800 to 1600. The one following the Great Recession of 2008 brought it from 700 to 3300. In these 1920s, once starting from 2300 in March, we could push it to 5-6000 in the middle of the decade, a large but less large rise than last decade.
The problem, at that point, will be to understand if we will have reached the possible peak of this still young cycle or if we will also be at the peak of the secular cycle that began in the 1980s. Christopher Cole, who has been pushing his studies much further back for years, points out that all of the narratives in which we living have grown up are built on the last 40 years, which are an exception to the long duration. Testing today's prevailing strategies, from Risk Parity to the classic 60/40 split between stocks and bonds, Cole points out that they are sub-optimal and even risky if we extend the time series to the last 100 years.
As is well known, the great cycle that began in the 1980s is a cycle of disinflation without deflation, the best of all possible worlds for financial assets, both bonds and stocks. This was also the case in the 1920s, but the novelty, this time, is in the slowness and gradualness of the disinflationary process, in the decisive help of demographics (which is about to fail) and in the ability to keep it alive without falling into deflation. or, even worse, in one of those classic debt crises that marked history even before capitalism.
We know that to understand how long this cycle (and the megacycle of which it could be the swan song) can last, we will need to see what will happen to inflation. Disinflation has been the beneficial protagonist of these 40 years, rising inflation could change the profile of the next historical phase. It is now possible (and indeed likely) that inflation will start to rise in the coming months. But be careful, because that won't be the time to worry if not for temporary stock market corrections. In the first place, it is physiological for prices to rise at the beginning of a recovery with a brief flash that then tends to fall. Secondly, this time the central banks will strongly recommend us not to look, to turn away. So will they do themselves, as Evans from the Fed reminded us yesterday, saying that the 2.5 or 3 inflation will not be a problem at all.
Therefore, if we have 3 per cent in 2022-23, long-term rates will rise to 2-2.5 per cent, but the short part will remain stuck at zero. If these levels are exceeded, perhaps in 2024, curve control will take place for a time, with the central bank committing to buying an unlimited amount of bonds until yields return to the desired lows.
Since equities and credits are measured on rates and not on inflation, it is possible and probable that, in a general condition of a growing global economy and stable margins, stock exchanges could continue to rise even in the presence of increasing inflationary tensions. in the new context, even in a structural way.
At that point we will enter uncharted territories, because the growing financial repression (i.e. the rates artificially kept far below inflation) will begin to create increasing volatility and will pave the way, at worst, for a crisis of confidence.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/inflazione-ritorno-disinflazione/ on Sun, 07 Feb 2021 07:00:49 +0000.