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The economic recovery and reflation tailwinds wreaked havoc on stocks and other risk assets last week. As predicted in “Fixed Income’s year Ahead 2021: Short-Term Corporate Bonds & Legacy Non-Agency RMBS” yields at the longer end of the yield curve surged (bear steepening) with the US 10-Year Treasury reaching 1.61% (highest level in almost a year). Investors continue to reprice Federal Reserve (Fed) rate hike expectations as vaccine mobilizations and the prospect of additional stimulus paint an optimistic economic outlook. However, the recent rise in real yields and the velocity of those appreciations have weighted on stocks the most. However, behavioral shifts to normalization and vaccine research studies showing long-term projected societal successes lead to economic reopening and the potential outperformance from cyclical sectors. Additionally, with big tech companies trading on an aggregate price-earnings ratio of nearly 60 times, they remain heavily exposed to interest rate movements as they are priced for continuing price increases in future cash flow and earnings. Therefore, value cyclical stocks with fundamentally strong balance sheets, attractive beta, and a competitive position tied to economic activity could lead the way through the “Great Rotations.” Leisure, travel, entertainment, and other companies hit hardest by the pandemic may be the outperformers amid normalization growing pains.
Commodity “Supercycle”?
However, one area of the market we must mention after experiencing record gains amid an economic rebound is commodities. Society trends of population growth, electrifications, renewable energy/infrastructure/batteries, and concerns around climate changes have boosted commodity demand over the medium to long-term. Bullish sentiment on the asset class continues to increase (largest in a decade) on optimistic demand potential from government stimulus, near-zero interest rates, and a weakening of the U.S. dollar during an economic recovery. The Bloomberg Commodity Spot Index, which tracks price movements for 23 raw materials, has already gained approximately 47% since reaching a four-year low in March.
Source: Bloomberg
As discussed in “The Inflation Debate: A Macro Perspective on Finding Value in a Hazy Economy,” inflation expectations increasing worldwide have led to the surge in commodity prices. Within traditional portfolios, investors view commodities as a hedge to inflationary pressures. Inflationary fears driving commodity demand and loose monetary and fiscal policies put commodities in a position to continue to see post-pandemic gains. For instance, copper, which experienced its eleventh monthly rise in February to roughly $9,000 a ton, will likely see increased demand from the electric vehicle segment, one of the largest growing subsectors in 2020. Though supply conditions tightening and China demand resurfacing amid shrinking profit margins for processing raw ore into a refined metal can also bode well for Copper. “Dr. Copper” with a Ph.D. in economics looks to continue its’ predictor abilities in economic activity. Copper is not the only commodity experiencing a parabolic start to the year. Nickel topped $20,000 a ton, raw sugar approached a 10th straight monthly gain (longest streak in six decades), oil climbed to the highest level in almost a year (U.S. crude was up 22% in February), and silver approached highs not seen since 2013. Collectively, of the 23 raw materials tracked by the Bloomberg Commodity Spot Index, 12 of them had YTD returns above 10%, and 9 of them had YTD returns above 2%. Though Gold has seen a pullback due to rising rates and “profit-taking” amid the non-interest-bearing bullion, it remains a compelling investment for the medium and long-term as prospects for additional stimulus, and Fed interest rates remain on hold.
Additionally, in the long-term, the dollar could continue to slide, and gold will likely continue to remain a better cash reserve, especially with the spread between the inflation-adjusted value of gold tripling that of the inflation-adjusted value of the USD. It remains important to clarify that gold remains a long-term bull with near-term benefits for cash reserves amid rising inflation and a hedge to cryptocurrency volatility.
Source: Catalyst Capital Advisors LLC
Commodities’ V-shaped vaccine recovery could continue amid parallel structural fundamentals that drove commodity prices up during the early 2000s, such as the industrialization and urbanization in high-demand regions such as China. This potential “supercycle” of commodities is a “decades-long, above-trend movement in a wide range of base material prices” deriving from a structural change in demand. (“Super-cycles of commodity prices since the mid-nineteenth century,” United Nations DESA Working Paper, 2012). Green industrialization supported by the Biden Administration and social “need or guilt” can create a Capex cycle similar to the 2000s. Furthermore, increasing minimum wage, increasing household income, and full employment goals are positive on demand for commodities. The fundamentally strong housing segment, especially on construction and housing starts, are likely “sticky” post-COVID behavioral trends supported by historically low mortgage rates (though rising). In essence, the combination of 2000 level capital expenditures and the social rebuilding similarities as seen in the 1970s constitutes the mechanisms of the post-pandemic 2020s.
Source: Bloomberg
Referenced above, some may argue that it still seems too early to tell if we are in a commodity “supercycle,” however, it remains hard to ignore the cognitive arbitrages (behavioral shifts in the consumer that creates investing opportunities due to its’ impact on supply and demand economics) and social agendas driving the status quos of a post-COVID economy. Additionally, cycles like these are usually comprehended in hindsight, missing most of the appreciation. Regardless, a positive Capex matrix, supportive social infrastructure agendas and a booming housing market all may bode well for the qualitative factors driving demand of commodities in the near and medium-term.
