The fed new plan is to let the economy run hot, including an overshooting of inflation. However, there are doubts if monetary policy can really achieve that. Looking at inflation for the USD and Euro area both the Fed and ECB are struggling to create inflation and economic growth. This is not surprising. We believe that monetary stimulus is the wrong medicine to fight against a pandemic induced recession. Fiscal stimulus is the road to success. However, in the US the 5th fiscal package is stuck, the previous ones have nevertheless created some additional consumption, do-it yourself home building and rising asst prices,
The Fed has clearly indicated that they want to keep rates at zero for longer and they will let inflation overshoot so that on average the 2% might be reached down the road. Based on the recent 10-year history of CPI and PCE this would mean not only to overshoot but to stay at higher levels for quite a while. This, although not stated, would as well reduce over time the debt burden in real terms as it would get inflated away.
The US treasury market reacted with rising yields. US 10-year and 30-year yields rose 5bps and 9bps on the day, respectively, suggesting a “buy the rumor, sell the fact” trade.” A steeper yield curve can also indicate that the recession is over sooner than most economist expect, which is aligned with our view.
Nasdaq and S&P 500 have reached several new record highs, while at the same time volatility rose. I.e. most stocks were trading down, but the 7 giant stocks keep moving the US market. up. Depending on how one measures a bubble we can say it is still inflating (Fiq. 1) or growing stocks are already in a bubble (Fig. 2).
Fig. 1: Nasdaq 100 and Homebuilders have risen but are not yet reaching bubble valuation
Fig. 2: Growth stocks are in a bubble, but nobody knows when it will burst
Fig. 3: The Fed is not reaching their own inflation target
The US market rally is mainly driven by 7 tech stocks. The growth PE is at elevated levels of around 30 times while value keeps at moderate levels.
Fig. 4: Eurozone inflation is even lower, although their target is below 2%
Switzerland has just released its latest Q2 GDP figure, which came in at -8.2% (expected -9%). But that was no news, or the news was that it was even better growth than the forecasts by most economists. Today’s Swiss is that we might see a domestic driven V-shape economic recovery. Or at least that is what the KOF leading indicator tells us.
Fig. 5: KOF leading indicator
In the past the story would go on as our small open economy depends on export. But since the KOF indictor construction was revised it now forecasts mainly the domestic development. Only the Swiss industrial PMI gives now hints on how the export markets (Eurozone, China and the US to mention the most important ones) are developing. This indicator points to faster global growth like the German IFO.
The question is – are we going without a correction further up or will we see a set back in September. If history is any guide the Nasdaq 100 trades at a huge distance to its own 200-day average. In such a situation it was never a question if there will be a set back but rather when. Having said that we continue to stay positive for the market over the mid-term. Most institutional investors are still under invested. This can be seen for instance in the bull bear indicator which is still in the buy-area.
Fig. 6: BofA Bull & Bear indicator is still in the “buy” area
To sum it up the US government bond yield went up, we keep thinking that the US treasury yield curve is stuck at current levels and distorted by the Fed buying program. We prefer USD corporate although they are as well trading at high levels due to the Fed corporate bond buying program.
Gold is consolidating and is very volatile, but we believe at around USD 1’840 we have a strong support which most likely will not be broken. Therefore, buy the dip is a reasonable strategy.
Fig. 7: After the 10% drop in 48 hours gold is consolidating
The US equity market is driven by 7 stocks, while the rest is consolidating or has even lost in value over the last weeks. We would hope for a pullback in September and would use such a situation to increase our equity allocation. However, we cannot rule out that before the US election the market is not pulling back and therefore, we might just go up from current levels.
Don’t fight the Fed seems to be the consensus, which is scary. Citi group was the last bearish strategist which has given up and has risen its S&P 500 target. This normally is a good bear indicator. Nevertheless, we lie in an unprecedented time and we might see more unexpected market surprises in the week ahead of us.
Published: 28/08/20 by Blackfort CIO Dr. Andreas Bickel
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