For all the speculation about the upcoming taper, which we now know will start in November at a pace of $15bn per month and conclude by July…
… the main event this fall, if not this year, may be on the fiscal side, and specifically what is the final shape of the upcoming bipartisan + Build Back Better stimulus avalanche, which as BofA’s Michael Hartnett calculates will represent – at roughly $1 trillion in biparstian “infrastructure” spending plus some $3.5 trillion in Build Back Better reconciliation – some $4.5 trillion in “epic fiscal stimulus”, which at 20% of GDP will be more than double the size of the previous record stimulus and will represent the largest fiscal stimulus package of all time.
This stimulus, which will pass one way or another, would arrive at a time of 12% GDP growth (if plunging fast), 5% inflation, and 33% deficit.
Furthermore, the final size of the reconciliation package is, in BofA’s view, the driver for yields next 3-6 weeks – anything above $2 trillion = higher yields as stimulus shores up weakening US consumption & heightens inflation.
But stimulus or not – and for the sake of the economy and democrats there better be one – the macro backdrop is turning uglier by the day. As Hartnett notes, his macro backdrop for the second half is one of higher inflation, hawkish central banks, weaker growth, i.e. stagflation. At the same time, the investment backdrop is one of rising Rates, Regulation, Redistribution (3Rs)…
… and peak Positioning, Policy, Profits (3Ps).
This means that all else equal, investment returns will be low/negative for both stocks and credit in the second half, while the optimal H2 portfolio is a “barbell” trade of long inflation (e.g. commodities, TIPS, small cap, banks, Japan) & long quality (e.g. cash & defensive utilities, staples, healthcare, REITs).
And speaking of stagflation, Hartnett compares the current period to the three stagflationary phases of the-1960s/70s and concludes that “we are in phase 1 with phase 2 starting in 2022…”
1. 1965-68…inflation & interest rates breakout to upside from multi-year ranges, stock market peaks, but “stagflation” neither visible nor anticipated…equities outperformed via a “barbell” of small cap value and Nifty 50 tech outperform;
2. 1969-73…end of Bretton Woods & oil shock causes sharp rise in inflation ending Nifty-50 bull market & kick-starting volatility & commodity bulls;
3. 1974-81…inflation & real assets outperform all asset classes.
Needless to say, stagflation is hardly what your financial advisor ordered as equity and bond returns tend to be especially ugly during such periods. So will this time be any different? Alas, central banks already blew their load, and while the differential between monetary and fiscal policy remains, (with monetary policy driving absolute returns, while fiscal policy driving relative returns) what is coming is ugly on the absolute return side, since the pace of central bank bond purchases is decelerating from its record of $8.5tn in ’20 to just $2.3tn in ’21, and then to just barely positive $0.3tn in ’22 before turning negative.
