Reflation has arrived along with broad economic recovery globally but consensus views on the outlook remain too cautious, according to BlackRock. Animal spirits are returning to the markets.
The consensus numbers are further from BlackRock’s ‘Macro GPS’ forecasting model, which incorporates big data signals, than at any time since 2013, the BlackRock Investment Institute says in a paper published last week, ‘Waking Up To Reflation’.
Key views from the authors of the paper are:
. Reflation has arrived. US wage gains are feeding higher inflation and solid consumer spending, supporting profits in the face of rising labour costs. The analysis shows that profits can improve even with rising wages, which tends to be a hallmark of reflationary economic phases.
. This has been far from a typical recovery: Healing the post-crisis economic wounds has meant US businesses and consumers took longer to regain confidence and animal spirits. These now seem to be revving up.
. Tightly integrated financial markets and global structural forces, including high world debt levels, should anchor US yields.
. But BlackRock sees risks. US president-elect Donald Trump has raised hopes on looser fiscal stimulus, but the make-up of any changes is key. His approach to trade and foreign policy could present risks. Unexpectedly rapid US dollar appreciation could cause emerging-market (EM) instability with global spillovers.
The authors, Philipp Hildebrand, BlackRock vice chairman, and Jean Bolvin, head of economic and markets research at the firm’s investment institute, say: “Our Macro GPS signals more upside to consensus growth forecasts, suggesting that economists are still playing catch-up to the reflationary outlook. Over the past month, the G7 GPS improved further thanks to conventional economic data. Traditional data releases are starting to reflect the upbeat big data signals that had led the initial Macro GPS rise. Robust business surveys in the US, Europe, and China are all now showing a broad global recovery. Yet GDP forecasts have been slow to respond.”
In 2013, when consensus views also lagged significantly behind the Macro GPS numbers, this preceded a series of forecast upgrades.
The investment implications of all this include:
. The support for profit margins from better wages, spending and nominal growth supports BlackRock’s broadly positive view on risk assets and equities in particular.
. The authors see a risk of occasional yield spikes within what is still a structurally lower interest rate environment. Hopes for fiscal stimulus have lifted yields, but there are many unknowns about what the new Trump administration will mean for the economy.
. They see rises in government bond yields being anchored. Record world debt levels amplify the impact from any interest rate increases. Global yields and the adverse impact of further US dollar strength should act as a drag on US yields.
. Modestly higher yields support their view that the rotation into value and momentum shares away from low-volatility equities likely has more room to play out.
. Certain sectors may feel more pressure on margins from higher wages than others, in our view, such as those in the consumer discretionary and transport sectors.
* Greg Bright is publisher of Investor Strategy News (Australia)