During his two-day testimony before the Senate, Federal Reserve (Fed) Chair Jerome Powell did everything in his power to avoid the sticky question of rising inflation expectations. He talked about ‘some elevated prices’, such as chip shortages that could lead to higher car prices. But he simply refused to talk about the abnormally ballooned asset prices, the spike in long-maturity sovereign yields or Joe Biden’s upcoming $1.9 trillion extra stimulus package that is about to hit the street.
And it worked! Even though we all know that chip shortages are not behind the skyrocketing sovereign yields, the stock markets were painted in green, again.
The major US indices rallied, Asian equities reversed earlier week losses and activity in European and US futures hint at a positive start on Thursday as Powell’s ultra-supportive policy stance soothed investors’ nerves, who preferred burying their head in the sand regarding the mounting inflation expectations, and not necessarily due to a chip shortage that would boost car prices, but rather due to an overheating consumer demand, accumulation of record household savings that are ready to be spent as soon as businesses reopen, fast rising energy and commodity prices that have already translated in a record jump in producer prices, and there is probably no time before we see a similar, probably record uptick in consumer prices as well — excluding cars.
On the one hand, Jerome Powell being ridiculous in front of the entire world shows how much he is committed to get things straight in the US jobs market. But on the other hand, he is probably playing with fire, relying too much on past years’ disinflationary trend to assume that the consumer price inflation will remain under control. Time will show the potential of the accumulating consumer demand that couldn’t go through due to Covid restrictions. This is a first-time occurrence in our modern history and could well reverse the persistent disinflationary trend that Powell is talking about.
Anyway, the fact that the US 10-year yield hit 1.40% is a proof that investors are not fully satisfied with Powell’s relaxed position regarding the mounting inflation fears. But given that the Fed will continue pushing a massive amount of liquidity into the market via bond purchases, there is no reason or investors to abruptly halt equity purchases. They will at least wait until Biden serves the $1.9 trillion dessert before shifting away.
Due today, the US durable goods orders could confirm a jump to 1.1% in January versus 0.5% printed a month earlier, and the latest GDP data should point at a 4.2% growth in the fourth quarter, versus 4.0% printed a month earlier. Strong figures will likely encourage investors to dump more sovereign yields. But if Powell effect lasts more than a day, we shall not see a decreased appetite in equities.
Gold bulls remain undecided near $1800 per oz on whether to dump their holdings and move to sovereign yields at the current prices.
US crude extends gains despite a surprise 1.3-million-barrel rise in US crude inventories. We see a growing number of articles pointing at the possibility of a further rise to $100 per barrel. But we also know that when such talks hit the headlines, it’s often a warning that the wind is about to change direction.
Do as I say not as I do
Of course, the strong case for a rapid rise in consumer prices didn’t disappear overnight because Jerome Powell didn’t want to talk about it. And investors already talk about what to buy if the sovereign yields continued rising.
This brings me to the hot topic of the moment : the portfolio rotation to more suitable stock investments, which would better shoulder the rising costs as a result of an eventual tightening in global financing conditions.
In theory, tighter financing conditions should boost value stocks, which are believed to have lower price-to-earnings ratios, and therefore undervalued. Because the motive behind these stocks is earnings growth, they could better cope with tighter financing conditions and perform better than what we call growth stocks.
But some, including UBS say that growth stocks should remain the winners in the long run. They actually emphasize that in times of liquidity tightening, as the one we will see once the life gets back to its normal pace hopefully, growth stocks have marginally outperformed value stocks. They say that all returns will fall due to higher financing costs, but growth would do better than value in the long run.
But more importantly, we shouldn’t forget that right now, the average price-to-earnings ratios have gone well ahead of themselves, either we are talking about growth or value stocks. So, in terms of historical metrics, we can assume that all stocks are, and trade as if they were growth stocks. You won’t tell me that any stock out there is undervalued right now. And, looking at the governments and central banks’ determination to push more cash in the system, it’s maybe just better to go with your regular, most loved growth stocks and just forget about what’s next. Because if there is will there is way. Jerome Powell made clear yesterday that he will find a way to deal with rising inflation, while keeping the financing conditions lose enough.