ASX investors have embraced news that the US Democratic Party now controls both houses, but it isn’t all good news for equities.
You’d be forgiven for thinking otherwise though with the The S&P/ASX 200 Index (Index:^AXJO) surging 1.6% to finish near its intraday peak on Thursday.
The Australian share market isn’t the only one rejoicing at the “Blue Wave”, a term coined to describe how the Democrats control all three layers of government.
US stock benchmarks also jumped last night and the futures market is pointing to further gains when their market opens later this evening.
Blue Wave reflation trade to flood markets
The party will soon install the next president, Joe Biden, while it controls both the Senate and the House. This will enable President Biden to push through just about any legislation.
Investors are excited because they expect the Democrats to launch a much larger stimulus program that’s targeted at lower income families. The market is betting on the Mother of reflation trades because the assumption is that lower income consumers will spend any government handout.
Return of inflation and higher rates
This means inflation is likely to return with the US bond market pricing in a more than 2% inflation rate on average for the next decade. This is the first time since November 2018 that inflation is tipped to jump above 2%.
Equity markets love growth, but it isn’t all good news. Once ASX investors come off their high, they will soon realise that there will be winners and losers from the Blue Wave.
This is because one consequence of large stimulus is a weaker US dollar. The US government will have to go much further into debt to fund this reflation trade.
Currency headwind for ASX stocks
A weaker greenback must lead to a stronger Australian dollar. That’s not good news for many large cap ASX stocks as they derive a significant proportion of their income in US dollars.
When they convert revenues to Australian dollars, investors here will get less bang for their buck. Some of these currency losers include the CSL Limited (ASX: CSL) share price, Amcor CDI (ASX: AMC) share price and James Hardie Industries plc (ASX: JHX) share price – just to name a few.
Risk free rate to climb in 2021
Another potential negative is rising bond yields. The US 10-year government bond yield has jumped over 1%.
As I’ve highlighted last week, at some point, the increase in the benchmark yield will lower the valuation of equities.
No one knows exactly where this tipping point is, but I don’t think we are far from it, especially given how little bad news is priced into stocks.
One possible group of ASX winners
On the flipside, I see the Blue Wave as being a big positive for the gold price, and ASX gold miners by extension.
A falling US dollar that’s triggered by burgeoning US government debt will prompt investors to search for safe havens outside the world’s reserve currency, which is the greenback.
As much as crypto aficionados would like you to believe, Bitcoin doesn’t cut it as a substitute for institutional investors. This puts gold in prime position.
Where to invest $1,000 right now
When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for more than eight years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*
Scott just revealed what he believes are the five best ASX stocks for investors to buy right now. These stocks are trading at dirt-cheap prices and Scott thinks they are great buys right now.
*Returns as of February 15th 2021
Brendon Lau owns shares of CSL Ltd., Evolution Mining Limited, James Hardie Industries plc, and Newcrest Mining Limited. Connect with me on Twitter @brenlau.
The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of CSL Ltd. The Motley Fool Australia owns shares of and has recommended Amcor Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
- AMP (ASX:AMP) share price on watch as second buyer for its asset could emerge – March 3, 2021 10:26am
- The latest ASX shares that brokers have upgraded to “buy” – March 2, 2021 12:19pm
- ASM (ASX:ASM) share price jumps as scoping study supports $45m plant build – March 2, 2021 10:25am