It is interesting to see/hear the big divergence that has developed recently between the bullish and bearish opinions on the variants of the coronavirus. On the bullish side of things, we’re hear some health experts say that this the current “wave” of Covid will be the “last wave”…and comments like these are leading some market pundits to say that risk assets in general are going to rally significantly into the end of the year.
On the bearish side of the ledger, we have reports of big increases in cases in several parts of the U.S. We are also reading stories about Tokyo leaders saying that the “virus situation is out of control.” More importantly, China just partially shut down the third busiest container port in the world. This will further strain a global supply chain that has already been under considerable stress for a lot longer than most people had been thinking just six months ago. In fact, this newest development has taken things to the point where it could have a serious impact on the holiday selling season this year.
So, what’s it going to be? Is the Covid issue going to die down and enable the economy to continue to expand at a stronger rate…or are the variants going to cause enough restrictions around the globe to slow the rate of growth we’ve seen for the past several months?
Well, we’re not doctors or scientists (something a lot fewer people on Wall Street have been willing to admit in recent weeks), so it’s impossible for us to know for sure. However, we also have to consider one other possibility. We could see a situation where the variants do become a problem for an extended period of time, but the problems it causes in the supply chains creates higher prices and higher inflation. In other words, the third possibility to consider is stagflation.
The bigger question is, what does this mean for interest rates? Well, if you only look at the first two possibilities, it can leave you very uncertain and confused. If this current “wave” of the coronavirus dies down quickly and the economy continues to expand, long-term interest rates will rise. That, in turn, would cause investors to go back to the “out of growth and into value” rotation trade (that worked so well from August of last year until March of this year). However, if this “wave” becomes a bigger (more prolonged) issue, the economy’s expansion should slow and that should cause interest rates to decline. That, in turn, will cause the “rotation trade” to involved moving out of value stocks/groups and into growth ones.
HOWEVER, given the disruptions in the supply chain that a more sustained “wave” would create…and the higher prices that those disruptions would also create…it does not seem to us that interest rates are going to go back down to their recent lows any time soon. If the coronavirus dies down, the economy will expand further, and inflation will stay elevated. On the flip side, if the coronavirus continues to grow as a problem, supply chains will be disrupted further…and THAT will keep inflation high as well.
In other words, it is our opinion that EITHER WAY, inflation is likely going to be a problem for the rest of this year (and into next year). Therefore, long-term interest rates should continue to rise. With this in mind, we believe that the “rotation trade” we’ll see for most of the rest of this year will be one that consists of rotating into value and away from growth.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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