One week / one topic: The price of everything

What happened?

Muted US April CPI numbers and a miss in retail sales confirmed expectations of a slight decline in inflation and moderating consumer strength.

Goodbye stagflation, hello ‘immaculate slowdown’.

Stocks swiftly rallied to all-time highs and bonds also appreciated – slowdowns are not bearish equities, recession are – eliciting fond memories of something that looks more like a slowdown/QE trade of yore, as opposed to the more recent ‘bonds down and stocks up’ period.

If central banks don’t have to keep rates at current levels to vanquish inflation – or, heaven forfend: hike even further! – consensus is that they are then less likely to engender a recession along the way, and we can then all conveniently go back to finding new narratives to justify our paper gains.

Yet, while the collective obsession over the price of everything keeps exploring new depths – with increased focus on the second derivative of prices vs expectations (Is the change in inflation more or less than expected?) and composition effects (Inflation>Services>Shelter>Rent equivalents>Regional dynamics…) – at the moment it feels quite hard to identify ‘value’ across cash, equities and bonds.

If consistency is indeed the last refuge of the unimaginative*, might one then need to fully embrace the shift towards ‘bad news is good news’?

Our observations

• Fundamentals: Latest developments point towards resilient growth, moderating inflation and healthy consumers. Certainty is absurd of course, but the rationale for potentially reducing risk in portfolios rests almost solely on moderately expensive valuations – something that can persist for a very long time.

• Price action: Implied risk for both stocks and bonds has meaningfully come down, reflecting muted realised volatility as investors perceive less and less macro uncertainty. It would be easy to scream “Complacency!” here, but we also have to face the evidence of the catastrophes that didn’t happen - like the much-feared recession of late 2022.

• Investor beliefs: Investors in aggregate tend to struggle with agnosticism despite strong evidence that the future is unknowable. We are not observing fixation-levels yet, but the lure of the mythical ‘reflation trade’ might be too hard to resist and eventually lead to price dislocations.

So what?

On balance, we still have a ‘neutral-ish’ allocation to Equities overall, and we maintain our position in Chinese equities opened in late January even after its strong recent outperformance: +20% over the last month (white) vs +5% for the S&P 500 (blue).

Within fixed income, we express a preference in portfolios for long-duration DM government bonds where – despite bearing the ‘cost’ of an inverted yield curve – we prioritise more capital-efficient ways to achieve desired duration levels.