In recent history, we saw that, contrary to popular thought, the current bull market is not the rise of a new 2 year old bull market, but rather the frenzied last breath of an older bull run. 12 years old. If so, what awaits him that could stop him?
A vigorous post-pandemic recovery is underway, but it does not signal a new bull market, believes Craig Basinger, chief investment officer at Richardson Wealth. The pandemic crash and the recovery were just a “pause” in a larger bull market that began in 2010. It’s like a beach ball in water, compares Aidan Garrib, head of macro strategy global and research at Pavilion Global Markets. “The coronavirus pandemic has pulled the beach ball below the surface,” he says, “and with the recovery, that balloon rises into the air, but in reality the ball is still roughly in the same place it is. found before 2020. “
A 2-year-old bull market just doesn’t behave the way the markets currently do, Basinger and Garrib argue. At the start of a bull run, investors are cautious, the direction of the market is unclear, and equity issuance is weak. Right now, the appetite for risk is burning, IPOs and PSPCs are mushrooming everywhere, and indexes are constantly hitting record highs. All of these signs point to the end of a bull cycle, not the beginning.
Basinger and Garrib aren’t saying this bull is heading to the slaughterhouse tomorrow. The current conditions are still favorable, and the beast still has room to run. In fact, “I think it’s safe to say that the odds of a recession over the next 12 months are low,” says Basinger. And if there is a pullback, we believe it will be a buying opportunity. “
Inflation, the beginning of the end …
But what will herald the end? “Inflation and rising yields,” Basinger replies. But more specifically, that’s when inflation will cause central banks, essentially the Federal Reserve, to become hawkish and raise rates to curb inflation. “Central banks will respond by reducing quantitative easing and possibly raising rates,” continues Basinger. “And given how addicted the markets are to low rates, that will untangle the bull.”
As long as central banks remain accommodating and inflation remains under control, the bull should keep running. Well, maybe not, Garrib warns, “We are in a world where this accommodating position itself could end the bull cycle. “
The difference is what kind of inflation we will have in the coming period: will we see demand-driven inflation or cost-driven inflation? “Central banks love demand-driven inflation,” Garrib explains. You have high demand, consumers are buying, and businesses are able to pass their higher costs on to consumers. “
…On the other hand
However, cost inflation is another story. “This erodes profits,” Garrib continues, “as costs rise faster than prices, and these cost pressures can make it more difficult for businesses to pass costs on to consumers.” This leads to cost reductions, companies are reluctant to hire, prompting the recovery to stall.
Many parts of this scenario seem to be playing out right now. For example, in the key residential construction sector, activity in Canada and the United States is currently slowing even though mortgage rates remain unchanged at very low levels. On an annual basis, Garrib says, construction inputs increased 23%, on a 2-year basis, 17%. “It is worrying that sales of small homes are dropping sharply, as rising input costs make the price per square foot less attractive to buyers. “
Global factors also play a role. “Companies are starting to reconfigure supply chains to make them more resilient to shocks,” observes Basinger. While that’s a good thing, it’s probably not as cheap, which contributes to cost inflation. In the longer term, the disinflationary pressures of globalization are slowing down. And demographics are also softening on the disinflationary side as the inflationary momentum of millennials increases and disinflationary baby boomers fade away. “
The pressures that are intensifying now, especially in housing, help explain the recent “Fed speech,” Garrib notes. “Fed officials are bending over backwards, trying to promise continued accommodation, while appearing more hawkish about the timing of the cut. They are trying to balance easy financial conditions with a stronger dollar to temper gains in commodity prices that hurt manufacturing and housing. “
Soften the blow
But the shock of that moment will depend a lot on how central banks initiate their rate hikes, said David Sekera, chief US market strategist at Morningstar. In the United States, he expects the Federal Reserve “to give a lot of warnings to the markets before changing its monetary policy”. At each quarterly meeting, he will announce the modest implementation of a long-term tightening policy. For example, next fall he will say he should start reducing monetary policy in early 2022. In December, he will likely announce that the new year will see him start to slow his current monthly bond purchases to the pace. from 10 to 20 billion US dollars per month. Slowly. Slowly. Slowly. “The first rate hike may take place at the end of 2022, more likely at the start of 2023,” Sekera adds.
A rate hike is not a problem for Sekera, although it does not rule out two possible exogenous shocks to the economy: a new phase of foreclosure in response to the delta variant of the coronavirus, and a more pronounced slowdown in the Chinese economy than what the markets have known. already priced.
So, barring trauma from left field, this bull could still ride, however, at a more leisurely pace, Sekera expects. “We believe the US market is currently trading at a 4% premium, which is in the upper end of the fair value range. The market has probably expanded too far, leading us to expect modest returns in the second half of 2021, compared to the 15% increase in the first half. “