Having just spent ten days on the beach in Ibiza, I am able to provide strong circumstantial evidence that European tourism is back, at least for a while. Granted, the clubs—which I am now too old to go to anyway—are still closed, but hotels, restaurants and beaches were full as ever. Given that 80-to-90% of activity on the island takes place outside, in a sunny and relatively windy coastal environment, the virus wasn't much of a threat, even though numbers had been climbing prior to our arrival. Indoor mask mandates, which are now commonplace, really was the only sign of the virus as far as we were concerned, notwithstanding having to navigate the byzantine testing and tracking rules for travel. The Dutch nurse who performed our pre-travel Covid-test informed me and my wife that tour operators on the island had hoped that August this year would see activity levels return to 50% of its 2019 level, before claiming that the true number is closer to 80%, and that operators are expecting to extend the season into October. If that's true, it adds to the evidence that economic activity in Europe will improve further in the next few months. That’s good news.
Read MoreMarkets have been propelled by a fairly simple story in the past nine months, split across two themes. First, market prices have been driven by the expectation that vaccination will once-and-for all allow us to put the virus in our rearview mirror, and secondly, that fiscal and monetary policy will remain primed for support. This story was always going to be challenged at some point in 2021 as vaccination programs reach their climax and policymakers inevitably begin to consider what degree of stimulus that is needed in a world not in the grips of a pandemic. And wouldn’t you know it; here we are. As far as the success of the vaccines is concerned, it is crucial to remember that the final path to a full reopening is as much a question of politics as it is about epidemiology. Indeed, at this point, I am inclined to believe that it is mostly about politics. This isn’t surprising. Cases were never going to zero—at least not as long as we keep testing at the rate we’re doing at the moment—and new variants were always going to elude the vaccines, one way or the other.
Read MoreI’ll keep it short this week, mainly because I don’t have much new to say. I continue to think that the tug-of-war between markets and monetary policymakers in fixed income markets remains the key spectacle to watch, even if I concede that we have been watching it for a while. There are economists and strategists who will tell you that policymakers are perfectly happy with steepening yield curves, and that they in fact welcome them. To believe this, however, requires that you forget the initial stages of the pandemic-policy response in which central bankers solemnly pledged to print as much money as needed—via QE—to keep rates pinned across all maturities in order to support the monumental fiscal efforts needed to prevent economic disaster. If you’re telling me that this tacit agreement is now broken on the eve of the new US administration is about to shovel €1.9T into an almost fully vaccinated economy—that’s just shy of 10% of GDP for those wondering—I have to concede that yields can, and likely will, move a lot higher. But is that really what you’re telling me? It seems to me that observers have quietly pivoted towards the idea that central banks obviously accept, even want, higher bond yields to reflect the recovery. I am sorry, but that doesn’t pass the smell test. While a steepening yield curve sows the seeds of its own destruction via an ever more attractive roll and carry, especially with fwd guidance on the front end, there is always a risk that markets end up questing the commitment to low policy rates.
Read MoreInvestors remain locked in discussion about the same issues they were mulling before the holidays. The rollout of the vaccine—however frustratingly slow in some countries—means that the light at the end of the tunnel for the economy is probably not an oncoming train. That’s great news, but the counterpoint is that markets have long since priced-in such an outcome, leaving investors vulnerable to the famous adage that if they’re buying the rumour, they’re also likely to sell the fact. In that vein, I am happy to double down on my comments at the end of last year that you should now be looking to stash away profits rather than putting new money to work. On that occasion I showed two charts to warn about incoming multiple contraction in equities, proxied by valuations on the S&P 500, and my in-house valuation score, which is also headed for the basement. The first chart on the next page shows that the six-month stock-to-bond return ratio in the U.S. remains pinned close to cyclical highs, also hinting that equities are about to give up some of their recent gains, with bonds rallying in appreciation. The second chart shows what happened the last time stock-to-bond returns were this stretched. It occurred in the run-up to the Flash Crash in 2010, before the swoon in the summer of 2011, ahead of the drawdown in May 2012, not to mention during the Taper Tantrum in 2013. Based on this albeit short sample, investors should brace for volatility in H1.
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