Central Bank Woes
After flooding the market with liquidity on top of massive stimulus spending by governments around the world, Central Banks find themselves backed against the wall. Inflation is rising and the need for accommodative policies has reached an end that bankers and investors alike don't want to accept. Tuesday's print of CPI surprised most and rising COVID cases due to the Delta variant has given some reason to hit the pause button on the re-opening prospects. Here's what we are seeing so far this week...
Inflation-driven Economy. Many were surprised on Tuesday when the June Consumer Price Index rose by 0.9%, when most expected the number to slightly drop to 0.4% from May's 0.5% reading. Some Central Banks have started to end emergency measures implemented during the pandemic. The Reserve Bank of New Zealand will stop bond purchases later this month, well ahead of schedule. The Bank of Canada has already begun tapering bond purchases. Bank of England policy-makers have recently signaled stimulus may soon come to an end in Britain. To make matters worse, Wednesday's print of the Producer Price Index confirmed the rise in CPI. June PPI rose by 1.0%, which was much higher than the 0.6% increase expected. Meanwhile, Fed Chairman Powell in testimony before Congress yesterday affirmed the Fed's view that the rise in inflation is "transitory." While he acknowledged that June's inflation number was higher than expected, he reiterated that it was too soon to scale back monetary support or begin tapering. He added that the Fed expected inflationary pressures to moderate soon. We agree that inflation is likely to recede slightly when supply chains and labor shortages correct, but the timing on that is still up in the air. We have reached elevated inflation levels before coming out of a recession (2011) only to see the numbers recede. Time will tell if the Fed is correct. A recent survey showed that 44% of those on pandemic unemployment relief say it pays as well or better than working. Clearly, extended pandemic benefits are affecting the behavior of potential future employees who are out of the workforce. Until these issues, brought about by poor policy decisions during the pandemic, begin to correct, we could see higher inflation for the next few months.
COVID-induced Fears. The rise in cases recently has given some reason to panic and investors cause to pause on the rotation from growth/momentum to cyclical/value. Since June 21st, when COVID cases began to rise in the U.S., Growth stocks have out-performed Value stocks by almost two-fold (5.50% vs 2.81%, respectively). In the 1st quarter, Value stocks had easily trounced Growth stocks by a margin of nearly 1100 basis points (11.26% vs 0.94%, respectively). We believe the panic/pause is a case of misinterpreted data. First, the rise in cases is to be expected as more countries re-open their economies. Japan, for example, had very few cases during the first two phases of the pandemic as a percent of the population (0.66%). Yet, while cases increase, deaths and hospitalizations are not following. Why? Put simply, the virus is declining as the number of infected & vaccinated continue to increase and medical facilities have become more adept at treating the virus. On Tuesday, global deaths from COVID stood at 8,118, a decline of 11% from just a few weeks ago when cases started to rise. Over that same period, cases have risen 17%. Recent data from the U.K. shows that the Delta variant has only 1 tenth the fatality rate as the original string of COVID, meaning that the cause for panic is severely premature. This would also mean that the pause in the shift from growth (pandemic-driven names) to value (cyclical, re-opening names) is also premature. We would expect the shift to cyclical names to resume as soon as the realization is finally reached that the pandemic has neared an end.
Overall Economics Good. There are several key economic releases still to come this week, so we'll see some positive and negative surprises today and tomorrow. However, the overall market metrics and broad economic indicators still point to solid conditions. The National Financial Conditions index showed little change from the previous week and is sitting at a very low level suggesting very loose financial conditions. This bodes well for stocks. In addition, there is no panic in the market, as evidenced by our Wealth Protection Signal. The Signal is sitting at 13.02, which means it would have to increase 246% to reach the 1st Cash Raise trigger. For now, it's steady as she goes and reason to get defensive at this stage.