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Additional points below regarding our view on the markets.
Table of Contents
Potential stimulus taper tantrum in the US
Stimulus tapering in the US is going to happen and is a good thing as it will reduce the probability of runaway inflation.
It is more likely that the US will leave bond-buying and rate where it is until towards the end of the year.
Talk of tapering is a good thing, it prepares the market for what’s to come and tests the market reaction.
Talks of taper haven’t had too much of a negative effect on the markets so far, the US market is still fairly stable trading in a range since mid-April.
The most important part of stimulus tapering is that the market is informed and that there are no surprises from the Fed.
Additionally, the last time the US tapered stimulus was in 2019 but there were no inflation expectations then. In fact, the market’s reaction was pushing towards an impending recession which brings deflation.
However, taper talks this time have been around a market that feels there is too much stimulus and that there is too much inflation.
The market sentiment this time around is going from an overheated market to neutral, as opposed to in 2019 when we went from neutral to recession fears.
This is a positive sign and in my view, the risk of a taper tantrum is significantly lower than in 2019.
COVID is still causing havoc in the supply and demand equation, with disruptions from inputs all the way to logistics.
As an example, COVID just partially closed a port in Shenzhen due to a COVID outbreak there.
Disruption in logistics also remains an issue with logistics costs five times more expensive than what it was before COVID.
However, I still believe that inflation is transitory. The disruptions are temporary and supply is still intact.
Inflation would only show up at the consumer level if the final product is marked up. So far, the supply chain and retailers have absorbed the price rises.
If the supply chain and retailers decide that inflation is not transitory or they can’t absorb the rise in prices anymore, it is possible that we could see a burst of inflation which can then become permanent.
For now, we still need more time and data to determine the extent of inflation and how it is affecting consumers.
How bad can inflation get?
If we do get inflation, it will highly unlikely to be much higher than 3-5%.
The last time we had high inflation was back in the ’70s when inflation reached 10%+.
However, since the 70’s we have had a number of developments that have diminished a number of inflation driving factors:
- The economy is now globalised. Demand is more easily met via global supply chains as opposed to back in the ’70s when manufacturing and skilled labour were localised.
- Due to globalisation, worker pricing power is much lower as companies can and have acquired much cheaper skilled labour overseas.
- Due to technology, there are a lot fewer inefficiencies within the supply chain and skilled labour which use to be areas that created bottlenecks.
- The aging population across the world is also diminishing disposable income. As the population ages, individuals tend to save money rather than spend money as their earning power diminishes.
- Higher asset prices such as housing relative to income mean there is much less disposable income available to spend.
Is the rally in gold a bearish signal?
I am currently not that concerned about the rally in gold.
Even though a rally in gold is usually strongly correlated to hedging as well as fear in the markets, I believe that the rally was partially driven by a rotation from Bitcoin.
Ever since the first stimulus in the US in mid-April 2020, we have seen a rally in Bitcoin but a sell-off in gold.
Even though there were inflation fears already from that point on, the sell-off in gold did not correlate to normal market behaviour.
Interestingly after the announcement of the 3rd stimulus in March 2021, Bitcoin and gold reversed course, with Bitcoin taking a dive from 65,000 down to 35,000 whilst gold rallied from a low of 1,680 to over 1,900.
This negative correlation is strong, at around -0.80 and I believe this correlation is caused by investors rotating from Bitcoin to Gold.
If I am correct, the rally in gold is more to do with gold catching up rather than a red flag of volatility to come.
A rising gold price is still a risk, however, so I view this as more of an orange flag as opposed to a red one.
I have written more extensively about my views on the relation between Bitcoin and gold here.
My view on the market
I continue to be medium and long term bullish.
However, I am cautiously optimistic as the potential taper tantrum as well as issues around inflation will dominate the rest of 2021.
I expect the market to test and then retest the 7200 all-time highs as well as find strong support at 7000.
I will be looking for the market to continue to mean revert between 7200 and 7000 in an accumulation phase before breaking the 7200 all-time high barrier sometime in the next month or two.
Potential downside risk catalysts that could break the 7000 support level will be dominated by news regarding tapering, CPI and other indicators of inflation.