Are money managers preparing for inflation?

It’s never a dull moment in global financial markets, but one finds it hard to believe we can replicate last week’s price action again and many will welcome a breather.

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Source: Bloomberg

There has been a substantial portfolio repositioning from investment managers and traders amid a view that parts of the developed world economies are really changing from one led by central bank monetary policy to one driven more by fiscal policy. Specifically, we’re changing towards Trump’s Reaganomics style of deregulation, reflation and nationalism.

What we saw last week was a genuine change in the thought process of many money managers, with some feeling we need to be prepared for inflation, while many others have been truly sceptical of the moves and note that while markets are firmly in the ‘hope’ phase there is great execution risk.

It does concern that we are seeing some stress in high yield credit spreads while US banks are flying (the XFL ETF was up 11.2% last week), with five year inflation expectations increasing a huge 20 basis points last week as the US yield curve steepens. Emerging market assets are getting sold quite aggressively (the MSCI emerging market index has lost 5.8% since the US election).

With the USD rallying for the past five consecutive days, the Federal Reserve now face the conundrum of rising inflation expectations, some concern in high yield credit and growing signs of stress in emerging market assets. A hike in December is no given, but a ‘one and done’ strategy still seems most likely at this stage, although if Trump can push through tax reform and spending plans, then we could see perhaps two hikes in 2017.

The ASX 200 etched out a 3.7% rally last week, with incredible turnover on Thursday and Friday. That being said, expect profit taking to be more active today, with our index call sitting at 5337 (-0.6%). Remember that this call reflects the 20 points subtracted from the market as WBC and ANZ go ex-dividend on open.

The materials space has been where the short-term traders have been active all year, especially those who focus on trend and momentum. That being said, the outperformance in this space is now so great for those who are cautious when others are greedy that this sector is one that is just a little too hot.

Year-to-date the materials space has gained 38.5%, relative to energy (the next best performer) with a move of 3.6%. Look at the price action in copper on Friday. Price traded to $2.73 p/lb, but subsequently fell a massive 8.3% into the close – how telling is this reversal? Much has been made of moves in iron ore, with spot closing up 7.7% on Friday, but importantly steel futures lost 1.6% and I would be looking closely at this commodity as a leading indicator this week. BHP should open modestly lower and I would expect a fall of about 0.5%.

US crude has fallen 3.2% from Friday’s ASX 200 close as well and we have seen the S&P 500 energy sub-sector falling 1.7% on Friday. Gold continues to find absolutely no love in the market, with price reacting to higher developed market bond yields and a stronger USD, and losing $56 since Friday’s ASX 200 close. Gold is looking a touch oversold here, although some are talking about a test of the May lows of $1200. There is no denying that, from a technical point of view, being long gold other than for a short-term bounce into the 7 October low of $1241 is a low probability trade. One for the radar.

We turn our focus to China again today with October retail sales (consensus +10.7%), industrial production (6.2%) and fixed asset investment (8.2%) due at 13:00 AEDT. On Friday we saw the monthly credit and financial data showing a far more stable approach to credit growth. Here we saw M2 at 11.6%, but new CNY loans for October dropped from RMB1.22 trillion in September to RMB651 billion. This would largely cement a growing view that monetary policy in China is tightening somewhat given the rising risk of asset bubbles. One could argue this is another reason to take a slightly more cautious view on the materials space.

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