Blue Wave Bets Revive Reflation Trades All Over the World
(Bloomberg) -- Reflation trades are getting a new lease on life after the Democrats moved closer to Senate control in Georgia’s runoff elections.
Small-cap stocks and banks are winning, while the yield curve is steepening as a fresh wave of money gushes into bets tied to more economic stimulus.
The Russell 2000 gauge of mid- to small-cap companies rallied 3%, the biggest gain since November. In contrast, the Nasdaq 100 Index was down 0.3% on fears Democrats may raise taxes and tighten regulations on the tech behemoths. Rising bond yields also make near-historically high valuations harder to justify in equities.
Benchmark 10-year Treasury yields climbed past 1% for the first time since the March as market indicators of inflation expectations reached a two-year high. The most economically sensitive sectors from financials to energy led gains.
Wall Street has been fixated on the Georgia race, with reflation bulls counting on a Democrat sweep to usher in further fiscal support for an economy ravaged anew by the latest surge in coronavirus cases.
“Investors will now be dusting off the blue-wave playbook,” Paul O’Connor, head of multi-asset at Janus Henderson Investors, wrote in a note. “A Democrat clean-sweep should lift expectations for U.S. growth, with fairly obvious consequences for bond yields.”
In Georgia, Democrat Raphael Warnock has secured his victory, the Associated Press reported Wednesday. Jon Ossoff is seen holding a slim lead over his Republican opponent, with a narrow margin potentially sparking legal challenges and recounts.
Should Democrats win both seats in Georgia, they will gain control of the White House and Congress, making it easier to push through their agenda with Vice President-elect Kamala Harris empowered to break any 50-50 tie in the Senate.
Additional aid on the agenda includes support for state and local governments, another extension of enhanced jobless benefits and more stimulus payments like the $2,000 direct payments supported by both President-elect Joe Biden and President Donald Trump.
A $750 billion to $1 trillion pandemic relief package could emerge this year on top of the $900 billion in aid signed into law last month, Matthew Luzzetti, chief U.S. economist at Deutsche Bank AG, said earlier this week.
Whether you slice and dice it by quantitative factors, asset class or equity sectors, risk-on trades are rippling through global markets Wednesday.
The financial sector was the S&P 500’s best performer. WTI crude traded near a 10-month high, aided by the election results as well as Saudi Arabia’s announcement of a production cut on Tuesday. In emerging markets, currencies rose against the greenback and an MSCI index of their stocks reached a 13-year high.
The Biden presidency may further herald big changes for stock winners and losers, spurring choppy trading for discretionary and quantitative investors alike.
“Low inflation and falling yields have underpinned aggressive valuations across the technology sector and the building blocks are in place for these trends to reverse in 2021,” Eleanor Creagh, a strategist at Saxo Bank, wrote in a note.
U.S. value shares were beating growth stocks by 2 percentage points in Wednesday trading, MSCI indexes show. The momentum strategy -- which buys recent winners like haven technology stocks -- dropped more than 2%, according to a Dow Jones market-neutral index.
When yields and economic expectations are at their lows, investors seek protection in shares that offer a long-term profit story like Facebook Inc. and Alphabet Inc. Now, riskier companies that offer near-term cash flows such as value are rising while yields break out.
The Treasury yield curve steepened on Wednesday, with the 10- and two-year gap widening to the most since 2017. Five-year breakeven rates steadied around a two-year high. That suggests fresh support for trades sensitive to both the interest-rate cycle and economic growth.
Trend-chasing investors meanwhile may also add fuel to the stock rotation. Commodity Trading Advisors are likely cutting long positions in Treasuries and adding bullish bets on oil futures, according to Masanari Takada, a strategist at Nomura Holdings Inc.
Another fillip to the reflation trade: Coronavirus infections potentially peaking at the end of this month, according to Andrew Sheets of Morgan Stanley. The strategist, an early champion of cross-asset reflation trades, recommends copper, a proxy for global growth, over gold.
“You should physically have cases declining quite rapidly between now and the end of the March,” he said in an interview on Tuesday. “Once the market feels like it’s the last peak, that’s a really important psychological moment.”
©2021 Bloomberg L.P.