When the conviction of the market crowd is as bullish as it’s now, some long-term buyers discover it arduous to not really feel a twinge of unease.
Driving this has been an emphatic consensus view — equities might be lifted by the prospect of vaccines opening up economies hit hard by the Covid-19 pandemic, thereby releasing pent-up demand and unlocking excessive family financial savings.
Add in supportive central banks and the chance of further fiscal stimulus early subsequent yr, and lots of buyers see the makings of a strong market restoration. Ed Yardeni, a strategist with a bullish persuasion, thinks there’s even scope that the present rally might launch a “roaring twenties” decade.
Proof of a world reflation commerce choosing up the tempo is now displaying up in rising markets and a few commodity costs, two barometers of confidence in an enhancing financial outlook.
The Worldwide Institute of Finance famous this week “the most important ever one-month inflows for rising market equities and debt” at $39.8bn and $36.7bn respectively throughout November. And commodity costs led by copper and iron ore each climbed to seven-year highs this week.
On the similar time, there was latest broad weakness in the US dollar amid expectations of solely a restricted rise in 10-year and long term rates of interest throughout the subsequent 12 months.
A weakening reserve forex issues for a world financial system with giant dollar-denominated money owed. It additionally boosts overseas revenues for US-based multinational firms and pushes up inflation expectations.
However buyers with lengthy recollections know the way markets typically puncture hubris.
“We’re all saying the identical factor,” says David Riley, chief funding strategist at BlueBay Asset Administration. “The reflation state of affairs is a rock stable consensus.” He cautions that it might not final past a “catch-up commerce”.
So what might disrupt the present market consensus for 2021?
An apparent place to begin is the rollout of varied vaccines. Any delay in implementation or resistance in the direction of mass vaccinations early subsequent yr will hamper a clean reopening of economies, with the potential for chipping away at upbeat progress and company revenue estimates.
At present buyers are shopping for into analyst expectations of a chunky 20 per cent restoration in world company earnings progress subsequent yr, conscious that, popping out of a recession, these nations hit the toughest normally profit essentially the most.
Inside the MSCI All World index, trailing earnings per share are at the moment about 15 per cent under the 10-year actual pattern, based on Oxford Economics. Nevertheless, this masks “large variation on the particular person market degree”, with Europe and non-Asia rising markets lagging behind essentially the most.
A bumpier tempo of restoration within the coming months would renew concentrate on excessive debt hundreds accrued by firms and governments this yr on prime of already elevated beginning ranges.
Some buyers are conscious that the 2008 monetary disaster was adopted by debt aftershocks convulsing the eurozone from 2010 to 2012 after which a credit score crunch in rising markets in 2013 and 2014.
For now, the fairness market rally suggests a level of consolation with present excessive debt ranges. That stance is underpinned by expectations that central banks will maintain rates of interest at extremely low ranges.
However patrons of the worldwide reflation commerce might face an uncomfortable reckoning sooner or later. Sustained robust progress means increased rates of interest and doubtlessly a extra resilient US greenback that hits bullish world markets.
This highlights the significance of central banks and whether or not the US Federal Reserve does sign an exit technique from its accommodative method to financial coverage. An inflationary surge, dismissed by many as a result of giant output hole in lots of economies, would additionally warrant increased rates of interest. In flip, that would cut back the valuation premium for progress shares.
“Fairness buyers may very well be trying to ‘have their cake and eat it‘, with the view that simple coverage and a vaccine can restore financial progress and earnings however with charges unchanged,” notes Absolute Analysis Technique.
Conversely, modest progress and low consumer-level inflation are the same old penalties from economies with extreme debt hundreds. Secular stagnation and low bond yields might nicely prevail as soon as the present reflationary breeze ebbs.
That raises an vital facet of what has been a unprecedented yr for markets and the worldwide financial system.
The sheer quantity of stimulus and pandemic disruption opens the door to what David Bowers, co-founder of Absolute Analysis Technique, calls “a spread of outcomes for fairness buyers which are possibly a lot broader than many realise”.