The market has begun pricing in stagflation in the West – Episode 119 of Damien’s Midweek Markets

7 min Read Published: 02 Sep 2021

The 119th episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about how stagflation is affecting stock markets in the West.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 119

It’s been two weeks since the last show and the markets are still wrestling with the future direction of both inflation and economic growth. In recent weeks markets have struggled for direction in the absence of any lead from global central banks, in particular the US Federal Reserve.

A combination of rising Delta variant cases and disappointing economic data, not just in the US but also in China, alongside geopolitical tensions in Afghanistan, sent the 10 year US treasury yield tumbling to 1.228% and investors began positioning themselves for the reality of stagflation in the US and other western economies.

Last week I published an article highlighting how to take advantage of a stagflationary environment in the US and Europe and the investment funds that could benefit. But to give you some insight technology stocks and defensive sectors such as Healthcare (XLV), Consumer Staples (XLP) and Real Estate Investment Trusts (XLRE) would likely be among the biggest beneficiaries. If you want to see a copy of this research then you can take out a free trial of 80-20 Investor.

However, since the last show the meeting minutes from the US Federal Reserve’s last policy meeting were released. The minutes suggested that the Fed could decide to reduce its quantitative easing (QE) programme later this year. Back in 2013 we saw the market react negatively to talk of QE tapering back then. The bond market’s reaction became infamous (yields surged) while stock markets fell around 5%.

The Fed no doubt wants to try and avoid a repeat, although most stock markets around the world fell at least 2% in the days after the minutes were released two weeks ago. We saw a pick up in equity market volatility and there was concern it could escalate into something more troublesome, where all ships sink at once.

It meant that all eyes and ears were on Jackson Hole Symposium (a get-together for central bankers, economists and policymakers from around the world). Any hope of unguarded and off-script comments from central bankers was dashed when the event was held online rather than in person due to delta variant concerns.

Nonetheless, there were headlines produced from the event and depending on which you read there were suggestions that the US Federal Reserve was more dovish/hawkish than previously thought.

Based upon the market’s reaction since the event that took place at the end of last week, investors believe that the Fed’s monetary support is here to stay for a while longer, in the face of uncertain economic growth.

If you look at the sector performances on the S&P 500 over the last week, reflation trade beneficiaries (such as financials and energy stocks) have fallen while those sectors mentioned earlier that may benefit from a stagflationary environment have popped higher. Real estate stocks for example are up 3.5% since 30th August while energy stocks are down -3.75%.

Technology stocks also rallied. Both the S&P 500 and the tech-heavy Nasdaq 100 have set new all-time highs in the last few days. It reinforces why the last episode was titled “Equity market all-time highs should be welcomed not feared”. In the days afterwards, US stock markets fell but have since rebounded, making new all-time highs. The exception is the Dow Jones, which is understandable given its exposure to cyclical sectors.

In the UK the FTSE 250 clocked up another all-time high yesterday. While Asian equities (most notably Japan and Chinese equities) are still yet to break out of their downtrends they too have seen signs of life as investors began betting on new stimulus hopes from Chinese policymakers after more dismal Chinese economic data which suggested that China’s economy had been hit by its own delta outbreak. The positive sentiment fed back into Western stock markets at the start of September too.

But having said all this the one chart the market remains obsessed with is the 10 year US treasury yield. The 10 year US treasury yield remains in its downtrend currently sitting at 1.29%. However, we’ve seen a run of higher lows which means that the downtrend is being tested. Much will depend on whether yields finally manage to break higher, which appears to be the consensus prediction (although the market has been wrong so far this summer). If we break and hold above 1.3% that will be interesting. If yields can continue higher then we once again will see a lot of equity market rotation, just as we’ve experienced a number of times already this year.

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