Regard d'experts

Inflation/Deflation and the Dash for Growth

Toby Clothier, Head of Global Thematic and Strategy, discusses the hot topics of 2021 so far: inflation vs deflation and value vs growth.

The number one topic for global investors of all kinds in recent weeks has been the debate regarding Inflation vs. Deflation/Cyclicals vs. Growth. Whereas 2021 thus far, as we reach the halfway mark, has seen a dramatic rebound in Cyclicals and Value sectors at the expense of TMT/Biotech/Pharma/Renewables, the story of the last 4-6 weeks has been the precise opposite, with a fierce recovery in money-losing companies, Renewables, Biotech, CyberSecurity, and other Momentum factors. This divergence between the YTD trends and the more recent trends has led to a lot of head-scratching amongst our institutional clients and consequently a reduction in global equity trading volumes. The behaviour of the Bond Market is at the heart of this confusion. In response to much higher than expected inflation data globally, but especially in the US, US Bonds have not sold off, as one would have expected, but instead rallied quite strongly, with the 10-Year now yielding 1.47% rather than the 1.75%-2.0% that many - ourselves included - would have expected. This suggests a deflationary world in which it is logical to pay up for growth, although the current data is anything but deflationary. 

DASH FOR GROWTH?

The consequent slightly frenetic dash into growth stocks in the last few weeks has become something to behold. We have been doing equities for 27 years and so we witnessed the 2000 internet bubble and collapse first hand, and also the GFC. In short, we have seen a few cycles, but some of the recent events make even those two periods look quite tame. 

A few instances of the recent mania are as follows. We could list at least 20 situations like this but here are three, just to give a flavour of some of the more speculative behaviour:

VIRGIN GALACTIC (SPCE US) announced it had got a licence to operate from the FAA and immediately went up 40%. One assumes that a licence to operate is a necessary part of the business plan and we find ourselves wondering what would have happened if they had NOT got such a licence! They have reservations from 600 people at $250,000 each so potentially $150m of Revenue spread over the next few years. We are not sure what the TAM is for this product but clearly at $250,000 a go it will be a very limited pool of customers. The Enterprise Value of the company is now $12.6bln however, that being 220x forecast 2022 Sales.  
 

PEARL ABYSS (263750 KS), which we at GTS have been big fans of historically (our "Stock of the Year" in TMT in 2020, for example) announced approval for its newest game in China. This was not a massive surprise, to us at least, and the stock has always seemed cheap to us so far in fairness, but it nonetheless shot up 22% on near record volume in the 2 days since. 
 

LUMINAR TECHNOLOGIES (LAZR US) announced a small-ish (likely $20m over several years) contract with VOLVO on Thursday last week. On Monday this week, after hours, the CEO of Luminar filed to sell $180m of stock, via MS, and nobody raised an eyebrow. MS said that the stock is "only a small percentage of his holding" and is necessary for "estate planning" (the CEO is 25 years old, incidentally) but neglected to mention that the block, at $180m, is 3x greater than the value of his entire holding just 6 months ago. Also not mentioned was the fact that the stock is on 280x Sales and the company is heavily loss-making and yet to deliver its maiden LIDAR chip. Nonetheless the offer was actually upsized and priced at just a 4% discount to the previous close.

INFLATION OR DEFLATION?

Those who are buying into situations such as those detailed above generally fall into one of 3 categories: US retail investors, machines, and finally those who believe inflation is transitory and therefore free money will therefore be here forever. We do not believe this. We think inflation is not at all transitory and actually is not too far from being out of control and will bring with it a cycle of rate hikes and Central Bank Balance Sheet reduction, which will in turn have great consequences for asset prices, given we are in the 12th year of a bull market, notably in assets where momentum and TAM forecasts are the only drivers, rather than profits and Cashflows. There is, however, a fly in the soup of our thesis, which is complicating the picture and means one might have to look a bit more at what is happening in each country specifically. 

FLY IN THE SOUP?

The fly in the soup for the "reflationistas" lately, especially for the last month or so, has been the resurgence of the dreaded virus in numerous countries globally, with especial reference to Asia, where several countries hitherto untroubled are now grappling with waves of their own, and more specifically the Government response to those waves. In some countries, notably Australia, New Zealand, Canada, the draconian response to really very minor case numbers, suggests that a sense of proportion may have been lost along the way somewhere. On the other hand, the majority of US States are now pursuing a "business as usual" approach to life, on the basis that Covid cannot be eradicated but is getting less severe as, crucially, the link between cases and deaths appears to have broken down completely. Florida, Texas and the Dakotas and Carolinas were the earlier adopters of this world view - where the standard bearer from the get-go has been Sweden - and have now been joined by many more, with the dissenters, for now, being mostly coastal states. So in reality, for the economy of each country, what is important is not so much the case numbers - indeed in Australia and New Zealand they are tiny/non-existent and always have been - but more a function of how the Government in question thinks about the necessity/size of any response to those case numbers. Consequently we suspect those countries who are not overly alarmist going forward - it obviously helps if one has high percentages having received the jabs - will be the ones who experience the highest growth and vice versa. Ultimately this means that GDP growth will be more patchy and also more stop/start than it has been in previous cycles. This is new and to some extent, uncharted territory and it does to a degree explain why the last 4-6 months have seen a strong preference for cyclical growth/value etc but the last 4-6 weeks have seen completely the opposite as per the 3 examples we highlighted earlier. In a world of patchy stop/start growth, there will be more variations in GDP growth between different countries than we have seen in recent years. Consequently, for global investors, it will be more important going forward to pay close attention to the attitudes of politicians in each country regarding the virus/the efficacy of lockdowns vs the impact on broader health/the economy and so on. When it comes to government policy regarding the approach to tackling the virus, it is becoming increasingly clear that one size does not fit all. 

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Toby Clothier

Head of Global Thematic and Strategy

toby.clothier(at)mirabaud-msl.com