Will the bull keep running?

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Will the bull keep running?

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• New year brings hope, again: The global stock markets kept doing well in January 2021 also, with new highs, although new strains of virus are spreading and vaccines are going slow. Markets are ignoring even the American democratic chaos! Perhaps hope in Biden-era calm is high.
• Control of the Congress: With Senate also won by Democrats, the markets think that Biden administration won't be stuck in procedural gridlocks but move forward rapidly, and with certainty. 

1. Fiscal stimulus programme: President Biden is going to push a bigger one now, helping individuals and small businesses. Aim is to jump-start the economy, before the 2022 mid-term elections.
2. If in 2022 they lose control of Congress, then Biden will be ineffective (lame duck, like Obama in 2010). 
3. Professional expertise also now supports larger govt. spending to get growth moving again. Other than the Federal Reserve that wants fiscal sustainability, everyone wants more spending.

• Risks minimised: For Biden, there's no pressure to go for fiscal consolidation in near term. The risks of double-dip recession are now gone. Like in 2011, the Republicans won't be able to sabotage higher spending programme.
• Other certainties: It seems that sharp, radical policies won't arrive anytime soon, like sharp tax hikes or breaking up Big Tech or Wall Street. Centrism is going to rule as Senate stands 50:50. Radicalism won't pass, and that's what markets love. The US will have a stimulus, but not higher taxes. The final price of a stimulus is nobody's concern today.
• Present stance of US Fed: Under Jerome Powell, Kenyesian demand management approach has been taken, with the goal being maximising employment, and then price stability. Fed has declared that policy tightening won't happen for few years, even if inflation crosses 2 % mark. Monetarist inflation targeting is over (for now). Since Janet Yellen (ex Fed chair) is now Treasury Secretary (Finance Minister), political cover is also provided! Such policies mean a lower dollar.
• Future perfect: So now higher growth, loose monetary policy, higher corporate profits (cost cuts) and rise of inflation will arrive. This is the right environment for rise of stock markets worldwide. Commodities and EM equities will do well, and dollar will decline.  [EM - Emerging Markets]
• Risk factors: Experts may be under-estimating the inflation risks. Rising oil and commodity prices plus a weak dollar will push inflation in US upwards. Supply chain problems will give some firms pricing power (raise prices). The Fed won't raise rates even if inflation goes beyond 2%, but bond markets may react with surging bond yields.
• The name is bond: The Fed will try to continue the QE programme and also "financial repression", to keep long bond rates under check. But it may fail. The 10-year Treasury yields in US are now 1 per cent (August 2020 - 0.52%). This may reset equity prices everywhere. The bulls may be beaten.
• Key question: So can Fed ensure that despite rising inflation and higher GDP growth rate, bond yields won't climb? 

1. As inflation rises, managers will be under pressure to move allocations away from fixed income bonds, and into risk assets (stocks), because yields are too low today (that will push yields up)
2. Fed will not tighten, but can it contain the long end yields through QE and financial repression?

• Vaccines must work: The virus shouldn't mutate dangerously, and vaccines must work out. If by July this doesn't happen, markets will correct.
• Normalisation of easy money policy: The Federal Reserve (and the RBI too) will have to someday start normalising monetary policy. So QE has to taper down. That is when markets always react badly, and crash. Money will flow out of markets and into real economy. So being cautious is the only way forward.

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