ASSET REFLATION TAKES OVER THE RECOVERY TRADE
Bubbly Ben has engineered one of the most incredible liquidity driven rallies in the history of the stock market. The reflation trade, made famous by John Paulson, has been a huge winner for investors prescient enough to engage in it. The reflation trade has been primarily due to the prodding of monetary policy. After all, they don’t call it a “stock prod” for nothing. Ben Bernanke is literally herding investors into risk assets as they watch their cash produce less than lackluster returns at 0%. Investors remain over-allocated in cash and the obvious winner of this cattle prod market is equities (regardless of the fundamentals).
Some big banks including JP Morgan are paring back their recovery chatter as signs of slowing begin to surface:
History and data suggest that the recovery trade has played itself out, for the moment. Indeed, during the last two recoveries from US recessions, it was at this point that economists started getting disappointed by the data and began lowering growth forecasts. And the history of the last six US recoveries shows that equities rally reliably during the last three months of a recession and the first three to four months of recovery. But, then, the path is wide open, and anything is possible.
Add in the approaching end of an almost miraculously good year and investors can be forgiven for taking money off the table. We did some of that last month, but we do not see a good reason to go short on risky assets. This is because our economists give us no hint that they will lower
their growth projections and the second factor we have been relying on, asset reflation, remains in full force.
Nonetheless, they continue to think risk assets will outperform as investors are forced to reach for risk:
As we argued last week, moving toward a period of less excitement on economies and markets reduces uncertainty and volatility, and thus induces a continued flight from the asset class that feeds off risk––cash. We have called this the asset reflation trade and remain solidly attached to it. It shares with the recovery trade a taste for equities and credit, but in contrast, it is bullish bonds and bearish commodities (as the latter pay no income).
The recovery trade has been a great friend for seven months, but has lost power. We move it to neutral and rely instead on the flight from cash, the asset reflation trade, which is long all positive yielding assets.
It seems counter-intuitive, but despite the weak fundamentals of the underlying economy, the liquidity outlook continues to favor the risk trade. Bubbly Ben is engineering the greatest reflationary environment in the history of markets. I think most investors know the Fed can’t print us back to prosperity, but that doesn’t mean Bubbly Ben’s rally can’t last much longer. As Keynes famously said, markets can remain irrational longer than you can remain solvent.
Unemployment above 10% and steadily rising = no rate hike for a long, long time = higher bond prices and much higher equities prices and much, much higher gold prices that is until there is a massive short squeeze on the dollar carry trade (maybe sometime in late 2013 after unemployment reaches 20% and finally starts falling?).
FED, Government and Wallstreet will keep going until oil hit 120 dollar and house-and the real estate market will hit the same prices they were in 2007. People also seems to be buying and I think prices in the house- and the real estate market might very quickly go up because they aren’t building a lot of new ones and now the tax credit was extended.
Will they then be force to stop their money printing and/or increase interest rate although the economy might be weak or at least imbalanced?
Or lets say that the economy will improve a lot in half a year from now so FED has to stop their money printing and increase interest rate. Prices will go down and the dollar will strenghten. Because of all the liabilities in the US and to not jeopardize the new strong market, FED will not want to increase interest to much and prices will start to go back up. Is it this that Faber is talking about? Will this then happen in 2011?
Is it liquidity driven? Not so sure when reading P11 of the oocc report,where profits on equities derivatives are defying weather forecasts
It will be interesting to peruse on 3 rd quarter.
http://www.occ.treas.gov/ftp/release/2009-114a.pdf
I agree with TPC. My only concern is increasing volume on declines and decreasing volume on bull runs.
….little late ….but thanks
TPC Reply:
November 6th, 2009 at 5:23 PM
Been pointing out the reflation trade from Paulson and JP Morgan here for 4 months….
excuse me……i didn’t realize that….but it was the way you headlined it…
TPC Reply:
November 6th, 2009 at 5:42 PM
Either way, with Ben’s seemingly endless “accommodative” stance it might not be too late at all….
t Reply:
November 6th, 2009 at 5:53 PM
as much as i want to agree and play the game…t-bills don’t move , the flight to risk seems pushed , i don’t see the numbers moving out of safe havens yet.
TPC Reply:
November 6th, 2009 at 6:15 PM
Who knows at this point? This is an odd world we live in. No real signs of inflation, yet this trade has worked remarkably well. Something is very odd when all assets go up. Pure liquidity infusions in my opinion and nothing more. Can it continue forever? Most certainly not.
Asset reflation trade, but bullish bonds and bearish commodities? I’d love to hear the explanation for that one. Even if you can make the case for bullish bonds (interest rates staying low indefinitely & investors seeking yield), what would cause the current US dollar/commodity strong negative correlation to change? What am I missing? Are they saying that while rates will remain low, the US govt will stop pouring money into the system and thus we will get a low or no growth situation combined with ZIRP? I don’t see how the US govt will stop pouring fuel on the fire with such high unemployment. It would be political suicide. That being said, commodities are way too high-priced given the economic realities we face. Jam the equity markets but push down the commodity markets? Um, ok. Good luck with that one, Ben.
Strange times indeed. Dangerous as well. None of us, in our lifetimes, have seen a situation like this before. This makes predictions even less reliable than usual, and trading in general much riskier. The only thing we have clarity about is low short-term interest rates. As for the rest? Who knows.
Having avoided the damage of 2008 (had a plus year), and having eeked out gains this year as well, I have NO incentive to buy into equities regardless of how badly the Fed wants me to. Let them tempt and pressure. I’m not convinced. Nor greedy. I’ll gladly sit out and collect small gains via various strategies (like option writing). While I still believe it’s foolish to fight the Fed, it doesn’t mean we have to go along for the ride either.
Hey,
Could you send me the datasource(s) that you used to create the picture:
http://pragcap.com/wp-content/uploads/2009/11/jpm.PNG
Glen Bradford
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