Morning Notes — Yield Curve and Financials

Burke: The 2007 financial crises started the current period of disinflation, which has led to a 13-year cycle (so far) of growth sector outperformance.  Massive monetary stimulus with some limited fiscal measures were put in place to arrest the recession and reflate the economy.  But in the immediate wake of the financial crises, China decided to de-lever, which put further downward pressure on prices and bond yields.  The performance gap between growth and value widened.  The 2016 election results came with rising expectations of tax reform and US 10-year yields rose from ~1.80% to ~3.20% over the next 2 years and cyclical/value sectors enjoyed ~3 quarters of relative outperformance until rising US-China trade tensions cooled things down.  Global manufacturing PMI slipped into contraction and another massive Fed-led monetary easing cycle began in the spring of 2019.  Progress on a US/China trade détente beginning in September 2019 caused US 10-year yields to rise from 1.50% (to 2% by year end) and November global manufacturing PMI crossed back into expansion mode above 50.  Cycle/value sectors enjoyed a brief ~2 months of outperformance until the spread of SARS 2 in China led to local restrictions and then lockdowns and then global pandemic status.  Another massive Fed-led monetary easing cycle began along with a massive US government-led fiscal spending package worth $3T.  That brings us here…after 13 years of easy financial conditions with interest rates at 0%, bond yields below 1%, money supply growth of 24.2% and the promise that vaccines can fully reopen the global economy. 

Here: We have a pro-cyclical outlook for the first half of 2021 and expect outperformance from the sectors that lagged through most of 2020.  These are value sectors with Financials in pole position given our expectation of continued yield curve steepening.