Stock bulls find validation in reflation signals across commodity markets

Equity bulls who expect a global economic recovery to prolong the record-breaking rally in stocks can take some comfort from signals in commodity markets. Copper, iron ore and aluminum futures are around multi-year highs and the Bloomberg Commodity Spot Index is close to its strongest since 2014 after rising from pandemic lows. For optimists that signals an Asia-led worldwide rebound — soon be aided by the rollout of vaccines against the pandemic — can help global stocks extend an 11 per cent advance so far in 2020.

“The commodities rally is the reflation trade, which has kicked in very strongly” amid progress toward a Covid-19 vaccine, said Rupal Agarwal, quantitative strategist at Sanford C Bernstein in Mumbai. “Global equities should continue to do well as uncertainty is finally dissipating.”
 

Progress toward vaccines and easing US political uncertainty helped lift an MSCI index of world stocks to its best month ever in November while driving down the dollar.

Investors have begun piling into sectors of the stock market viewed as more sensitive to economic recovery, such as cyclical value shares and small caps.

The impending deployment of Covid-19 vaccines together with the impact of stimulus “are driving the expectations of a ‘V’- shaped recovery,” David Lennox, a resource analyst at Fat Prophets in Sydney, said by email.

The ratio of copper to gold — often viewed as a window on expectations for the global economy — surged this week to the highest since mid-2019. The climb in the S&P 500 index of materials companies has overtaken the technology-heavy Nasdaq 100 index’s rally since the March lows.
 

“In a typical recovery, commodities should be performing well,” said Kerry Goh, chief investment officer at Kamet Capital Partners Pte in Singapore. “The best link to this trade is industrial stocks.”

Revived talks toward fresh US. fiscal stimulus and the possibility of a return to normalcy next year sparked a climb in long-term Treasury yields in recent days. Stocks remain unperturbed, though that could change if inflation takes off and forces a rethink on monetary policy. One market-based gauge of US inflation expectations is at the highest in more than a year.

For now, Morgan Stanley and Goldman Sachs Group Inc. are among those painting a positive outlook for equities next year. Investors seem to be on board, looking past risks such as the outbreak lasting longer that currently expected or causing still more economic damage.

Sanford C Bernstein’s Agarwal recommends boosting positions in cyclical stocks and those exposed to Asian economies such as China, South Korea and Taiwan to take advantage of the stronger recovery.

Unprecedented monetary and fiscal stimulus is helping aggregate demand, and “a continued strong recovery in the global economy is a tailwind for reflation-sensitive assets,” said Wenting Shen,multi-asset strategist at T Rowe Price Group.