Investors remain locked in discussion about the same issues they were mulling before the holidays. The rollout of the vaccine—however frustratingly slow in some countries—means that the light at the end of the tunnel for the economy is probably not an oncoming train. That’s great news, but the counterpoint is that markets have long since priced-in such an outcome, leaving investors vulnerable to the famous adage that if they’re buying the rumour, they’re also likely to sell the fact. In that vein, I am happy to double down on my comments at the end of last year that you should now be looking to stash away profits rather than putting new money to work. On that occasion I showed two charts to warn about incoming multiple contraction in equities, proxied by valuations on the S&P 500, and my in-house valuation score, which is also headed for the basement. The first chart on the next page shows that the six-month stock-to-bond return ratio in the U.S. remains pinned close to cyclical highs, also hinting that equities are about to give up some of their recent gains, with bonds rallying in appreciation. The second chart shows what happened the last time stock-to-bond returns were this stretched. It occurred in the run-up to the Flash Crash in 2010, before the swoon in the summer of 2011, ahead of the drawdown in May 2012, not to mention during the Taper Tantrum in 2013. Based on this albeit short sample, investors should brace for volatility in H1.
Read MoreJudging by the latest virus numbers in Europe, and government announcements to contain it, markets may soon have to read up on the math of lockdown economics. Before we get to that, though, investors have been locked in deep thought over the impact of the U.S. presidential elections, which seems to converge on trying to price in the consequences of a Biden victory and a “blue wave”. As I explained last week, investors seem to have concluded that this is good outcome for risk assets, though as I argued at the time, this isn’t entirely clear to me. To illuminate this further, it’s useful to consider how markets perceive a Blue wave in the context of the dollar and the U.S. bond market. As it turns out, the consensus position isn’t entirely clear, which is a hint. If markets can’t figure out how a Democratic sweep will impact the dollar and bonds, it’s difficult to have any view on how it would impact equities. The dollar is particularly interesting. It seems to me that analysts initially pinned recent weakness—effectively since April—on the inherent political risks associated with a Biden presidency, though it has since morphed into a bullish catalyst in the context of the expectation of surge in fiscal stimulus, funded by a benevolent and compliant Fed. Why this latter should necessarily be bearish for the dollar isn’t clear to me, especially not if it led to stronger growth in the U.S. compared to the rest of the world. By contrast, the idea, voiced in some corners of the market, that the U.S. is on its way to print away its exorbitant privilege—in effect losing its reserve currency status—seems even more ludicrous to me, even in world where China is now emerging as a potential adversary.
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