Triple Peaks

In “What Markets Are Betting On,” I talked a bit about investors’ outlook for the macro and the implications for monetary policy.

Maybe “outlook” isn’t quite right. Rather, I recapped what market participants are hoping, both as it relates to an assumed abatement of the Delta wave and a policy bent that finds central banks loath to cut off the liquidity spigot amid signs that economic activity has likely peaked.

That latter possibility — that signs of deceleration will give central banks plausible deniability to drag out the taper discussion and otherwise keep policy ultra accommodative even as the pace of monthly asset purchases is trimmed — is a manifestation of the Afghanistan effect. There’s never a “good” time to exit stimulus. The “state of exception,” as Deutsche’s Aleksandar Kocic characterized it, is permanent.

But what are markets “betting on” in a more granular, literal sense? Well, that depends on where you want to look and what investor cohorts you want to talk about. A 30,000-foot view suggests the Value over Growth trade has yet to regain its footing. Value underperformed a third week headed into the holiday (figure below).

That’s just one of several reflation expressions that reversed its YTD outperformance as the virus darkened investors’ doorstep anew and the “peak growth” narrative gained traction.

Meanwhile, shares in companies with weak balance sheets have underperformed the likes of Adobe, Costco and Alphabet of late, as the “Three Peaks” macro bandwagon (i.e., peak stimulus, peak growth and peak profits) gets more crowded seemingly by the week. “We’ve been positioned for the end of peak growth, peak stimulus [and] peak accommodative policy,” Emily Roland, co-CIO at John Hancock Investment Management, told Bloomberg last week, for an article called “Peak Everything Puts Shine On Equity Market’s Sturdiest Stocks.”

Roland may as well have been reading directly from a Michael Hartnett note. Hartnett — BofA’s popular Chief Investment Strategist who pens the “Flow Show” weekly and runs the bank’s monthly Global Fund Manager Survey — has long been a proponent of the “peaks” narrative. “Long quality, particularly defensive quality in credit and stocks [is the] best market and macro hedge in a backdrop of stagflation and waning fiscal and monetary policy stimulus,” he said, in his latest note, adding that staying long commodities as an inflation hedge is probably a good idea too.

The visuals (below, from BofA) speak for themselves. But just in case, Hartnett spoke for them. “The global population is 7.8 billion and on November 1, 7.8 billion global vaccines will have been administered,” he wrote. “Yet the 5.3 billion vaccines thus far in 2021 have failed to boost reopening versus lockdown trades and bond yields in recent months.”

Similarly, Morgan Stanley’s Mike Wilson pivoted away from early-cycle trades months ago. “Cyclicals and small-caps led the charge earlier in the year as the market contemplated the distribution of vaccines and a reopening of the economy [but] in mid-March, we pivoted to a new narrative, labeling it the ‘mid-cycle transition’,” he said last week, recapping the evolution of the bank’s view on equities as the recovery unfolds.

“Mid-cycle transition” is (basically) just another name for the “peaks” thesis. Wilson describes it as “the period when markets contemplate the peak rate of change in growth and policy.” The annotations in the figures (below, from Wilson) depict the transition.

Quality has outperformed small caps over the past several months, a period during which markets pondered the Delta variant and various iterations of a “growth scare” narrative, exacerbated by the notion that the Fed was on the brink of a policy error following the June FOMC meeting, when the dots tipped a hawkish bent.

All of that said, consider that the latest flows data showed high yield bonds taking in the most in 10 weeks while Treasurys saw the largest outflow since February. Emerging market stocks, meanwhile, enjoyed their biggest haul since April.

“The most notable move inside the Rates space may actually be within US Equities ETFs, where it seems there was a ‘reflation reallocation’ worth noting into Fall / Q4,” Nomura’s Charlie McElligott said Friday, flagging a $900 million outflow from BlackRock’s 7-10-year Treasury ETF, the biggest exodus since November and “two outlier inflows” into an iShares real estate fund and a TIPS product.

“Notionally, these ETF flows are not the end-all, be-all of course [but] the reallocation is simply more evidence of [an] ‘openness’ from investors to take another shot on bearish fixed-income / bullish reflation themes into the back part of the year,” Charlie remarked.

So, while the “Peaks” narrative is ascendant in some corners, market participants aren’t ready to throw in the towel on reflation altogether. And neither, by the way, is everyone on Wall Street. It was just two weeks ago when JPMorgan’s Marko Kolanovic wrote that “we believe bond yields and cyclicals bottomed and are now on an upward trajectory for the rest of the year.”