The market had a bit of a delayed reaction to the US Federal Reserve’s latest statement yesterday.
The Nasdaq woke up and realised that if the Fed doesn’t mind inflation going up and doesn’t really mind interest rates going up either, then that’s not great for the “growth” stock boom.
Yet at the same time, oil prices collapsed too. Does that mean the “reflation” story is a goner as well?
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Let’s have a look at what’s going on.
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Covid-19 is no longer big investors’ top fear
As you might know by now, I like to keep an eye on the Bank of America monthly global fund manager survey. It tells you what the world’s big institutional investors are thinking, as well as giving you some idea of where they’re putting their money.
When their opinions hit extremes, it’s usually a signal to do the opposite. That’s not because these people are stupid; it’s simply because they represent all the money in markets. And if all the money has flooded into one asset or one strategy or one position, then there’s no more money left to push it up any higher. Therefore, you’re better to bet against it.
So what does the latest one suggest? Well, it’s clear that betting on inflation is no longer (if it ever was) a “contrarian” idea. Big investors are now finally convinced that they can put Covid-19 behind them. It’s been the top “tail risk” in the survey since March last year. But it’s now been demoted for the first time, and all the way down to third place (also note that it’s the efficacy of the vaccine rollout, rather than a rampant resurgence that everyone is worried about now).
Now investors are worried about two clearly interlinked dangers. The first is “inflation”. Or more specifically, their biggest worry is “higher-than-expected-inflation”, rather than simply a nice cuddly “reflation”.
The second biggest worry is “a ‘tantrum’ in the bond market”. This is where everyone sells bonds very quickly, yields (ie, interest rates) surge, and that knocks everyone off their perch until the central banks rush back in to mop things up.
Meanwhile, a record number of investors expect a stronger economy. And a record number think that profits will be higher.
In normal circumstances, that would be a warning sign. However, you have to accept that we’ve just been through a wildly unusual downturn. You would have to be very gloomy indeed to imagine that the economy won’t be better this year than last, or that corporate profits won’t be better this year than last.
Also, history suggests that the corporate profits indicator is not a contrarian one in any case. Previous peak expectations include February 2002 (a good way through the tech bust) and December 2009 (by that point the global financial crisis was already behind us).
However, where views are more extreme is in expectations for inflation and for reflation. The consensus bet right now is on cyclical stocks and commodities. Even the UK is finally getting some respect (though to be clear it’s still way down the “positives” list).
Bullishness on commodities is particularly extreme. In fact, the last time investors were this excited about the sector was in February 2011, which was about three months before the last commodity bear market began in earnest.
In short – investors were worrying about bonds, and heavily betting on commodities, before the Fed came out and delivered its latest view of the economy and monetary policy. So what does that tell us about the reaction?
Is the “Great Rotation” intact?
Certainly, it seems that the market had a proper think about the Fed’s relaxed stance on monetary policy from the other night, and started to realise that not much had really changed.
That explains why bond yields continued higher (the Fed didn’t express any real worry about them), and why the Nasdaq decided to take another tumble (higher interest rates mean higher discount rates which means the value of all those lovely currently non-existent future cash flows is less) .
However, it’s clear that bets on this particular outcome – higher inflation and higher growth – have become overstretched. You have to expect that to happen sometimes. As more and more investors have become a little frenzied and rushed to jump from one big story to another, you’re going to get big swings in sentiment and positioning as investors look for evidence to prove or disprove their shift.
I suspect that’s one big reason for oil falling hard yesterday – i’s gone up an awful lot (about 30% this year); it needed to take a breather. I don’t think it’s any more complicated than that.
As for whether the “great rotation” from growth to value is intact, I present a piece of anecdotal data. James Anderson, head of Scottish Mortgage Trust – which, in the UK certainly, is the one fund most identified with the long “growth” stock, “jam tomorrow” bull run – has this morning announced that he’s leaving Baillie Gifford next year (we’ll be writing more on this in an upcoming issue of MoneyWeek magazine – if you’re not already a subscriber, get your first six issues free here).
They say they don’t ring a bell at the top. And I’m pretty sure that Anderson’s successors will do a good job, too. But the reality is that there are often plenty of signs of exhaustion once a trend is done, and this could well be one of them. We might be entering a phase where the likes of Scottish Mortgage are battling against the tide rather than rushing along with it. (To be clear, that’s not necessarily a reason to sell it. We hold it in our own model investment trust portfolio alongside our value and “bear” market trusts because that’s the point of diversification - you don’t bet the house on the market going in any one direction.)
Anyway, in all, my own view is that we still probably have a bumpy ride ahead until the market forces central banks to be a bit more explicit about exactly how high they will allow bond yields to get before they start to worry about public sector solvency.
But I’m pretty convinced that the “great rotation” is a real one, and that it will continue. So I’d stick with your value stocks and your commodity exposure (and own some gold, boring as it is). And I’d just audit your portfolio for exposure to growth and bonds and other long-duration assets that have done well over the last decade or so.
