先進国

Highlights Don’t trust market inflation expectations or real interest rates. When inflation is near-zero, think in nominal terms not in real terms. New structural recommendation: Underweight inflation protected bonds versus conventional bonds. For the time being stay overweight stocks versus bonds, but sell stocks if the 10-year T-bond yield rises by 0.3 percent. We address four concerns about inflation raised by clients. Fractal trade: short copper versus gold. Don’t Trust Market Inflation Expectations Or Real Interest Rates Are the markets any good at predicting inflation? No, they are not (Chart of the Week). Both the inflation forwards market and the breakeven inflation rate implied in inflation protected bonds have been lousy predictors of inflation.1 We can forgive that. What we cannot forgive is how these markets derive their inflation forecasts. Chart of the Week AThe Markets Are Lousy At Predicting Inflation Chart of the Week BThe Markets Are Lousy At Predicting Inflation Expected inflation in the UK just tracks the commodity price index (Chart I-2), and expected inflation in the US just tracks the oil price (Chart I-3 and Chart I-4). This link between expected inflation and the level of commodity prices is absurd, for three reasons: Chart I-2UK Bond Markets' Expected Inflation Just Tracks Commodity Prices Chart I-3US Bond Markets' Expected Inflation Just Tracks The Oil Price Chart I-4US Inflation Swaps' Expected Inflation Just Tracks The Oil Price Inflation measures a change in a price. Therefore, inflation expectations should not track the price level of anything. Even if expected inflation is incorrectly tracking a price level, a lower price today will increase the scope for future inflation, and vice-versa. Hence, any relationship with the current price level should be an inverse relationship, not a positive relationship. Most absurd of all, how can the level of commodity prices today conceivably forecast the inflation rate five years ahead through 2026-31, as the inflation forwards seem to be suggesting? There are two important takeaways from the absurdity of inflation expectations. First, it follows that the market’s estimates of the real interest rate must also be lousy, and taken with a huge dose of salt. The market’s estimates of the real interest rate must be taken with a huge dose of salt. Second, as the market’s inflation expectations just track commodity prices, the relative performance of UK index-linked gilts versus conventional gilts just tracks commodity prices too (Chart I-5); and the performance of US TIPS versus T-bonds just tracks the oil price. Nothing more and nothing less (Chart I-6). As we expect the structural bear market in commodities has much further to run, the structural recommendation for bond investors is: Chart I-5UK Index-Linked Gilts Vs. Conventional Gilts = Commodity Prices Chart I-6US TIPS Vs. T-Bonds = The Oil Price Underweight inflation protected bonds versus conventional bonds. When Inflation Is Near-Zero, Think In Nominal Terms Not In Real Terms If the market is lousy at predicting long-term inflation, then it might also be lousy at predicting the long-term nominal return on equities. After all, shouldn’t prospective inflation impact the prospective 10-year nominal return on equities? The surprising answer is no. The prospective 10-year nominal return on the stock market depends only on the stock market’s starting valuation. The 10-year nominal return on the stock market does not depend on prospective inflation, it depends only on the stock market’s starting valuation. The same relationship between the stock market’s starting valuation and prospective nominal return applied in the high-inflation 1970s and 1980s as it did in the low-inflation 2000s (Chart I-7). Chart I-7The Stock Market's Starting Valuation Establishes The Prospective Nominal Return, Irrespective Of The Inflation Backdrop The reason is that the stock market’s 10-year nominal return has two components: the income through the 10 years, and the terminal value at the end of the 10 years. When inflation is high, the income component is larger, but the terminal value component is smaller – because in an inflationary environment the market will demand a higher subsequent return, requiring a lower price. When inflation is low, the opposite is true: lower income, but higher terminal value. These effects cancel out, so the result is a prospective nominal return that is independent of prospective inflation. Crucially, the required prospective return on equities in excess of bonds is also established in nominal terms. This is because the bond yield’s lower limit is nominal, at say -1 percent. Proximity to this nominal yield limit makes bonds very risky because there is no longer any upside to price, only downside. Witness Swiss bonds this year. As the riskiness of equities and bonds converges, the required prospective nominal return on equities collapses towards the ultra-low bond yields. The upshot is that both the prospective return on equities and the required prospective return on equities should always be calculated in nominal terms, never in real terms. Right now, the high valuation of the aggregate stock market means a very low prospective nominal return, and this valuation is hypersensitive to ultra-low bond yields (Chart I-8 and Chart I-9). Chart I-8The Stock Market Is Priced To Generate A Feeble Long-Term Return Chart I-9AUltra-Low Bond Yields Have Created The Greatest Asset-Price Inflation Of All Time Chart I-9BUltra-Low Bond Yields Have Created The Greatest Asset-Price Inflation Of All Time For the time being stay overweight stocks versus bonds, but as we warned two weeks ago, Sell Stocks If The Bond Yield Rises By 0.3 Percent. Four Concerns About Inflation Raised By Clients In this section, which is in question and answer format, we will address four concerns about long-term inflation that our clients have raised. 1, Isn’t the unprecedent fiscal stimulus in 2020 setting us up for inflation down the road? No, not in itself. Understand that the unprecedented stimulus is in response to unprecedented shocks to incomes that have come from the rolling waves of the pandemic. As incomes disappeared, governments provided income-substitution. As and when incomes reappear, governments will withdraw the income-substitution. Indeed, the UK government tried to withdraw its income-substitution (furlough) scheme prematurely and had to backtrack when the virus resurged. This illustrates that the unprecedented fiscal stimulus is a much-needed stabiliser of the economy, rather than a source of inflation. 2. But if governments want a bit of inflation, they can get it, can’t they?  No. Understand that inflation is a non-linear system with two states, price stability and price instability. You can shift between these two states, but you cannot get a ‘little bit of inflation’ in a controlled fashion, or hit an arbitrary inflation target like 2 percent, 3 percent, or 5 percent. This is something that we have been arguing for years, and it is comforting that some great thinkers – like (the late) Paul Volker and William White – fully support our non-linear system thesis. You cannot get a ‘little bit of inflation’ in a controlled fashion. Any government can take its economy into the state of price instability if it so chooses. Witness Turkey and Argentina. But price stability is the much better state to be in. Given that developed economies have expended decades of blood, sweat, and tears to reach the state of price stability, we think that it would be a monumental policy error to embark on the road to price instability (Chart I-10). Chart I-10Inflation Is A Non-Linear System With Two States, Price Stability And Price Instability 3. But doesn’t rampant Argentina-type inflation bail out the heavily indebted? No, not necessarily. It will only bail you out if your debt is a one-off lump sum payment in the distant future. If your debt requires ongoing refinancing, then inflation will not bail you out, because the refinancing interest rate could rise in line with, or even faster than, the inflation rate. Therefore, those highly indebted governments, firms, and households that need to refinance their debts would not benefit from rampant inflation. 4. In which case, isn’t the solution to let inflation rip while keeping interest rates depressed – so-called ‘financial repression?’ No. While it is conceivable that a government could corner its government bond market and thereby repress it, it would be near-impossible to repress the much larger asset-classes of equities and real estate. Once these large and privately priced markets sniffed out the government’s nefarious plan, the required prospective nominal return would surge as a compensation for the higher inflation. The result being an almighty crash in stock and real estate markets. Given that the near $500 trillion combined worth of such markets dwarfs the $90 trillion global economy, the impact of such a crash would make this year’s pandemic feel like a waltz in the park. Fractal Trading System* This week’s recommended trade is short copper versus gold, given that the spectacular relative outperformance is showing fragility in both its 65-day and 130-day fractal structures. The profit target and symmetrical stop-loss is set at 10 percent. Chart I-11Copper Vs. Gold In other trades, long RUB/CZK reached the end of its holding period with a marginal partial loss. The rolling 12-month win ratio now stands at 53 percent. When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated   December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 Europe and the US have deep and liquid markets in 5-year 5-year inflation swaps (or forwards), which price the expected 5-year inflation rate 5 years ahead. The current swap measures the annual inflation rate expected through 2026-31. The UK and the US also have deep and liquid markets in inflation-protected government bonds: UK index-linked gilts, and US Treasury Inflation Protected Securities (TIPS). The yield offered on such a security is real, which means in excess of inflation. The yield offered on a similar-maturity conventional bond is nominal. This means that the difference between the two yields equates to the market’s expectation for inflation over the maturity, known as the ‘breakeven inflation rate.’ Fractal Trading System   Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

Dr. Copper has gone ballistic of late, breaking out to multi-year highs. While there is an element of speculative fervor, global growth is ascending and China’s demand for commodities remains insatiable (top panel). Copper’s recent spike signals that EUR/USD will likely decisively break above the 1.20 ceiling (bottom panel), a message that China’s immense easing corroborates as we highlighted last week. The Fed was adamant in debasing the US dollar as a way to reflate not only the US but also the global economy as we highlighted early on in the recovery in early-May. Now the Fed has passed the baton to investors and USD bears are squarely in control. The implication is that a positive feedback loop of a falling currency and rising global growth is great news for commodity producers. We expect a V-shaped recovery in the cyclicals/defensives profits on the back of the budding economic recovery the world over (middle panel). Bottom Line: Continue to prefer deep cyclicals at the expense of defensives.

The SPX has breathed a sigh of relief and has slingshot higher in November to the tune of 10%, reversing two months of losses and springing back to all-time highs. Equity flows have been spiking and investor bullishness is near three year highs according to the bull/bear ratio from the American Association of Individual Investors. This worry-free market with nearly every asset class on “risk on” mode last month (second panel) is worrisome to us and eerily reminiscent of January 2018. As a reminder, back then investors priced in the Christmas 2017 fiscal easing package in a mere 20 trading days in January 2018, that morphed into the “Volmageddon” 10% drawdown in February 2018. Today, the SPX recovery has been even more violent than in early 2018 and everyone seems to be on the same side of the boat risking capsizing. This complacency is showing up in an intraday VIX print below 20 last week, and a stampede into low quality highly-indebted stocks (not shown). An element of a short squeeze is also at play (third panel). While most investors are neglecting the COVID-19 cases news and the Google trend mobility data as has been the case since the March lows, the bond market is sending a different message (bottom panel). If the next 25bps move in the 10-year Treasury yield is to the downside, then the risk is that in the near-term the SPX may retest the recent lows as the rotation trade would go on hiatus. Bottom Line: We remain cyclically and structurally bullish the SPX but in the near-term stocks are fully priced and have likely stolen some of next year’s return.