Summary

Gerard described how in 2021 fiscal dominance could bring the curtain down on secular stagnation. Whilst Discussing the state of the real economy this year, the growth rebound led by goods producers, shows real consumer spending. Durable goods have bounced a long way, services have lagged, reflecting governments sending cheques to consumers, but limited how they can be spent. The pandemic has contributed to a strong bounce in housing. In the US there is excess demand for housing, whilst we have also seen a significant decrease in new housing since the GFC. Autos, in which production fell more during the pandemic than the GFC, is likely to see roaring demand over the next couple of years. Fiscal policy is moving from households and small businesses to infrastructure and environmental projects - spending that will have a bigger impact on the goods markets and will lead to a pick-up in services. fiscal stimulus does not directly reverse underlying causes of secular stagnation, it provides an effective antidote through excess spending across the public sector. Unemployment in US has drastically declined, especially when comparing to previous recessions. Financial markets have already assumed the economy has healed, so a lot is already priced into the markets. Expect global equities to give positive but mediocre returns; however, most importantly, the post GFC cycle led by tech, consumer discretionary and healthcare should now give way to more basic industries / high beta goods producers. The main thing to be expected is rotation; the longer-term perspective is if we do move to a world of fiscal dominance and see an extended strong cycle, we can talk about “the great reflation”. Gerard goes on to discuss the relationship between rates and equities. It is not true to say that low rates lead to higher equity valuations. When bond yields are falling from high levels, equities do tend to rerate, but when bond yields start to fall to very low levels, equities are likely to derate, reasoned by macro conditions. If we see a sustained strong macro cycle this could result in excellent equity returns outside of the US. There cannot be anything more bullish for Japanese equities than JGB yields rising to 2%. US markets are very vulnerable to a de-rating as they are at extreme premium valuation levels. Gerard discussed how a narrow reflation trade blending into a multi-year great reflation environment through sustained aggressive fiscal stimulus could lead to some unacceptable rates of inflation. But he doesn’t believe that this is this year and doesn’t believe that it will trough until the first half of 2022 which would be in line with other cycles. Real problematic inflation readings are unlikely to surface until 2023. Although look out for a short-lived spike in a few months due the base effects. Regarding Commodities, clearly there have been price increases, but one needs to realise how unimportant goods prices are on core inflation. Services, when compared to goods, is a more important contributor to inflation. Post GFC, services was a modest contributor due to soft wages. Inflation is unlikely to appear until we get a labour market tight enough to see a serious lift in wages. Notwithstanding the strong employment growth seen from the lows in April, non-farm payrolls in the US remain further from the prior peak, even at the worst of the GFC. Overall, even if this remains a strong recovery, there won’t be serious constraints in the labour markets until 2022 at the earliest.

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