At Center of ‘Erratic’ Market Moves Is a Raging Recovery Debate
(Bloomberg) -- Eye-popping moves across asset classes have captured the attention of Wall Street, inciting a dispute over what’s behind all this.
Precious metals are surging while inflation expectations rise, the U.S. dollar is under pressure, and value stocks are getting a boost. Bitcoin is even surging again. One view holds the moves are interconnected, and unprecedented stimulus measures will act as a foundation to an economic recovery that eventually lifts prices. Another sees record gold prices, for example, as a sign of budding nervousness.
“This is not a textbook kind of recession. The usual things that might lead to the end of a cycle and a reverse aren’t really in place this time around,” said Amanda Agati, chief investment strategist for PNC Financial Services Group. “You are definitely seeing much more erratic performance and behavior in the market.”
Below is a run through of the perplexing market moves, and how some investors view their interconnectedness.
Gold and silver have been on a tear. Gold staged a record rally as futures touched $2,000 an ounce for the first time. Through Monday, spot silver prices were up 29% in 10 days, the most since 1998. Spot gold had risen in seven straight trading sessions, the longest streak in a year.
A variety of reasons have been cited for the rally, including prospects for a pickup in inflation amid stimulus measures, low real interest rates, and a weak U.S. dollar. Bill McMahon, chief investment officer of active strategies for Charles Schwab Investment Management, sees it as a rush to safety.
“When you see gold being as strong as it has been, it’s definitely telling you something,” McMahon said. “It’s probably reflecting a heightened sense of nervousness around risk assets.”
Bitcoin, which some advocates call “digital gold,” also got a boost on the notion that it’s an alternative investment that should act as a hedge against inflation and provide uncorrelated market returns. Near $11,000, Bitcoin surged to the highest level in almost a year Tuesday.
Gold’s dizzying rally has done little to entice investors to the companies that mine the metal. Roughly $95 million exited the $19 billion VanEck Vectors Gold Miners exchange-traded fund, ticker GDX, last week despite the ETF’s 6.4% climb. Traders yanked an additional $33 million from the fund on Monday, even as the GDX surged to its highest level since 2013.
The fact that the miners’ rally has yet to be fully embraced shows that investors are too pessimistic on the inflation outlook, according to Societe Generale SA’s Sophie Huynh. Unlike bullion -- which is hovering near its all-time high -- miners still have room to run before hitting their 2011 peak. The next leg of the rally will be unlocked once markets begin to significantly rethink their expectations, Huynh said.
“We need a specific scenario: Inflation repricing. If we are in a deflation scenario, gold miners won’t do that well,” said Huynh, a global asset allocation strategist. “Medium-term inflation expectations are really underestimated.”
Under the hood of the world’s biggest bond market, the inflation debate is heating up. Though the Federal Reserve’s pledge to keep rates low has locked Treasury yields in a range, real interest rates -- which strip out the effects of inflation -- have dropped deeply into negative territory. The plunge is cited for pushing investors into gold during its record run.
Meanwhile, breakeven rates -- a proxy for anticipated annual increases in consumer prices -- have quietly climbed higher in recent months from decade-low levels. To TD Securities, that gain suggests the market expects the Fed to allow inflation run above the central bank’s 2% target should price pressures ever return.
“It’s largely a Fed-driven trade, both on expectations of more or longer-dated QE and expectations that stronger forward guidance will allow the Fed to overshoot inflation in the coming years,” said Gennadiy Goldberg, a senior U.S. rates strategist at TD.
Equity Reflation Trade
Strategists attributing the gold rally to increasing prospects for inflation are looking for the so-called reflation trade to appear across equity markets. Charlie McElligott, cross-asset strategist at Nomura Securities, expects U.S. inflation expectations to continue to rise, acting as one of the most important positive drivers for stocks from a macro perspective.
“This newfound investor ‘openness’ to a potential reflationary impulse -- largely due to risks perceived from potential for fiscal stimulus ‘spillover’ -- is such a shift,” he wrote to clients Tuesday. That should help set up an environment in which value and cyclical stocks outperform, while growth and tech lag, he said.
According to Dennis Debusschere, Evercore ISI’s head of portfolio strategy, positioning across stocks for a reflationary scenario has increased, but “is not suggesting anything like gold,” he said in an email. Net long S&P 500 futures positioning among large speculators, such as hedge funds, “has improved significantly” while those betting on volatility has declined from a recent high.
The flipside of the gold rally is the dollar’s free-fall. Investors fleeing the dollar in favor of gold have dragged the Bloomberg Dollar Spot Index down by over 9% since March 23. That dynamic has gained steam in recent weeks, with the gauge on track for its worst July in a decade.
Rising U.S. coronavirus case counts coupled with massive stimulus programs from the Fed are also weighing on the greenback. While the dollar also fell when the Fed initiated quantitative easing in 2008 and 2009, it gained as the U.S. economy rebounded in response. Now, with certain states being forced to roll back reopening plans, any economic recovery is likely to be delayed, according to Brown Brothers Harriman’s Win Thin.
“What’s different now is that the rising U.S. virus numbers are likely to delay a rebound,” said Thin, the firm’s global head of currency strategy. “Europe is likely to outperform in the third quarter and fourth quarter economically. That is translating into dollar underperformance.”
Michael Zigmont, head of trading and research at Harvest Volatility Management LLC, views the weakening dollar in a more positive light.
“If we see a weakening dollar, as long as it’s not a huge weakening, I think that is the global market indicating faith that economic activity is on the rebound,” he said. “I’d be looking at the dollar as a measurement of global economic health expectations.”
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