Reflation is still the dominant driver for 2021 - Macquarie Bank
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Investment Strategy Update #39
Reflation is still the dominant driver for 2021
• Reflation will remain the dominant investment growing valuation risk (particularly as fears of inflation
driver in 2021 despite concerns around slow begin to rise).
vaccination rates, new (potentially vaccine
resistant) COVID-19 strains and uncertainty
around the size of fiscal policy support.
• Rising inflation and stronger economic growth will
push bond yields higher but, fears they will rise to
levels that undermine the equity bull market are
premature.
• Australian equities will be supported by a stronger
than expected recovery in corporate earnings
(similar to nearly every piece of economic data
since mid-2020), but market composition will
continue to act as a headwind for absolute returns.
• It is “consensus” that value, cyclicals, financials Since the beginning of November, the US equity
and small caps will be amongst the best market has risen 17.5% with the Australian market
performers in 2021. While the direction of macro lagging slightly, but still up a highly commendable
fundamentals supports this stance, there is 14.7%. High teen returns over a 3-month period are
enough uncertainty to continue to hedge this out always going to raise tactical correction risks.
via maintaining some growth exposure (i.e. a However, our views on 2021 have not changed (see
barbell between value and growth rather than a “2021 Investment Outlook: A faster than expected
seesaw in favour of value). return to normalcy”) and our conviction in “reflation”
being the dominant investment theme for 2021 has
A lot has happened since most people broke for the only grown in recent weeks as President Biden has
holiday season back in late December. President super charged expectations around fiscal stimulus
Biden has been sworn in as well as the Democrats following his US$1.9tn proposal.
taking control of the US Senate following the Georgia
run-off elections. New strains of COVID-19 have Ultra-accommodative monetary policy, record low
emerged alongside on-going lockdowns across borrowing rates, elevated debt levels, extremely high
Europe and growing disappointment on vaccination levels of personal savings, rapidly rising retail
progress across some of the hardest hit nations. participation (on fear of missing out and the idea that
Bond yields have doubled from their late 2020 lows, there is no alternative to equities), elevated valuations,
yet equity markets (after rising more than 10% in plus sizable levels of new fiscal stimulus are certainly
November) have continued to rally through both conditions that can drive speculative excess (and
December and January. There is growing talk of ultimately bubbles). As a consequence, markets will
markets becoming overly stretched and oblivious to require close monitoring in the months ahead,
Macquarie Wealth Management | Investment Strategy Team 1
particularly as signs of excess are evident in some base effects – as the price falls in March and April last
areas (i.e. cryptocurrencies). year drop out of the y/y calculation – and the rebound
in oil prices. Further out, we do not expect a
significant and/or sustained increase over the next
couple of years.
However, we think the outlook for equities remains
appealing and investors should remain focused on the
prospect for an even stronger than expected
economic rebound where the threat of slower than This is because many of the structural factors that
expected inoculation rates and/or new strains of have contributed to lower inflation have not gone
COVID-19 continue to be offset with additional policy away and COVID-19 has also led to significant levels
support. of excess capacity that must first be eaten into. More
importantly, inflation poses the biggest risk if it causes
central banks to alter their policy settings and forward
guidance as well as a willingness by central banks to
let inflation run hot, suggests the policy response
(which is what matters most for markets), is still some
way off.
As far as rising bond yields are concerned, we again
think the narrative is becoming overly pessimistic.
• First, the start of the year is always
accompanied by expectations of rising bond
yields (the power of positive thinking given the
“consensus” rarely forecasts the next year to
We think this is no better summed up than by the be worse than the last);
recent comments from Janet Yellen (past Chair of the
US Federal Reserve and current Secretary of the • Second, we don’t think inflation is likely to
Treasury for the Biden Administration) where she has rise much;
said policy makers should simply “go big” (shades of
• Third, central banks are likely to keep tight
ex ECB President Mario Draghi’s 2012 “whatever it
control over yields and yield curves; and
takes” moment….).
At this stage, we think concerns around inflation and • Fourth, we are great believers in bond yields
rising bond yields undermining the equity market are being the self-regulating mechanism on
premature. Macquarie expect inflation to materially growth which means in the absence of
increase in the months ahead. But, this will be due to shock, they tend to be reasonably well
behaved.
Macquarie Wealth Management | Investment Strategy Team 2
yields as the trigger for popping the equity bubble
sometime in 2021 appear premature.
Yields will rise and curves will steepen but tighter
financial conditions will be met with more central bank
easing / bond buying. It’s too early to fear the end of
the cycle and while there are areas of speculative
activity already evident, we still think the catalyst
(spark) for a sustained and prolonged correction is
lacking.
Value stocks should follow economic growth higher
Our best guess is that bond yields range trade
through 2021 somewhere between 0.9% - 1.5%
for the US 10 year and between 0.8% -1.3% for
the AU 10 year. At these levels, we don’t think
they would be sufficient to drive a sustained de-
rating in equity markets (albeit – they will add to
pressure on some growth areas).
In sum, while concerns are rising around the rapid
Source: MWM, January 2021
gains made by equity markets, we think they remain
appealing and will be supported by ongoing easy
We stick to our equity overweight and fixed income
policy, the reduction in social containment policies
underweight with a preference for economically
and a strong fiscal pulse that ensures 2H21 economic
sensitive areas. Property is no longer a short while
growth is turbo charged.
growth stocks will not universally de-rate in the
Fears of runaway inflation and bond yields are absence of run-away bond yields or sustained
overdone. Inflation will pick up but it remains too early economic growth – neither of which is likely.
to tell whether this increase is sustainable or
meaningful (at this stage its just a risk). Similarly, bond
Jason and the Investment Strategy Team
Macquarie Wealth Management | Investment Strategy Team 3
The report was finalised on 25 January 2021.
Recommendation definitions (Macquarie Australia/New Zealand)
Outperform – return >3% in excess of benchmark return
Neutral – return within 3% of benchmark return
Underperform – return >3% below benchmark return
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Macquarie Wealth Management | Investment Strategy Team 4
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