A “quality” factor could be a company’s positive earnings revisions representing a hybrid of growth and value, revisions that bring with them lower forward multiples, she said.
She also suggested rebalancing. “A strategy we’ve been suggesting for investors is to consider volatility-based versus calendar-based rebalancing, in the interest of adding into weakness and trimming into strength a more subtle form of buy low and sell high.”
Sonders said she’s been asking herself lately whether the Covid-induced recession launched a traditional economic cycle or instead interrupted one. Or perhaps it was something entirely different.
There are some late-cycle alarms that have been ringing lately, including the inflation backdrop of course, Sonders admitted. “The key question is whether Covid’s toxic brew and its impact on supply chains is a setup for 1970s style stagflation? In short, there are more differences than similarities. The purest definition of stagflation includes high and rising unemployment, clearly in contrast to today’s extremely tight labor market. While productivity is much stronger today as well.”
Secular forces tend to shift and create either a prevailing inflationary or deflationary backdrop, “but psychology also comes into play, when the psyche of workers and companies changes and each decides they can use their power to demand higher wages, pass on higher costs persistently. That’s when the so-called wage-price spiral kicks in,” she said.
There are two broad categories of inflation. Pro-cyclical inflation occurs when stronger economic activity drives prices up. Countercyclical inflation occurs when high prices drag economic activity down, Sonders explained.
“I think the risk is that we have shifted from pro-cyclical to countercyclical inflation. For now, we have moved from an age of abundance to an age of scarcity. Interdependencies, low inventories across global supply chains have created a pretty fragile system that’s become more vulnerable to shocks and their ripple effects, including the global energy crisis,” she said.
So what will the Federal Reserve Bank’s reaction be? “We all know that the central bank’s policy tools can do little to ease bottlenecks in the global supply chain, but a risk is that the Fed will have to tighten policy more quickly than anticipated to quell demand,” she said.
Perhaps a more benign scenario is that high prices cure high prices with lower demand. “In other words, might inflation protect us from the Fed before the Fed feels it has to protect us from inflation?” Sonders asked.
Clearly, the Fed’s ongoing promise of liquidity has had an important psychological impact on equity investors, and this is why concerns about the coming tapering remain front and center. “The reality, though, is that the growth rate of liquidity peaked in February. Not coincidentally, many of the market’s most significant drawdowns began at that inflection point. Certainly, that was the case among the speculation-fueled non-traditional market pockets,” Sonders added.