by Albert Edwards, Cross Asset Research, Société Générale
Surveys suggest that inflation fears have become investorsâ number one concern. But why look at it that way? We could equally say it is investorsâ own bullishness on the strength of this economic cycle that is driving prices sharply higher in the most cyclically exposed equity sectors and industrial commodities.
âą Bloombergâs John Authers recently pointed out in his excellent daily note (link) that there is a âreflexivityâ to investorsâ belief in rising inflation. For when they pile into commodities as an investment vehicle to benefit from rising inflation, they create substantial upstream cost pressures â as has been highlighted by PMI corporate surveys. Beyond the cascading effect of upstream commodity price pressures, headline CPIs are also quickly impacted as food and energy prices rip higher.
âą In addition to this, the observation by investors that industrial commodity prices are rising only serves to reaffirm their belief about cyclical strength and rising inflation - most especially âDr Copperâ, which many investors see as extremely sensitive to economic conditions.
âą The circular, or as George Soros terms it, âreflexiveâ nature of financial markets makes them extremely vulnerable to being whipsawed. Yet because of the current extreme momentum it would take a very heavy weight of evidence to convince this market to reverse direction.
âą We continue to highlight that commodity prices are at high risk of a major reversal because of the steep downturn in the Chinese Credit Impulse. We have highlighted this before and we are not alone â see chart below from Julien Bittel of Pictet Asset Management (you can follow him on Twitter via @BittelJulien).
âą When commodity prices do start to fall, expect a major reversal in inflation sentiment. And expect momentum to become as self-reinforcing and reflexive on the way down just as it was on the way up! Indeed, technical
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