We need to talk about deflation, again [Update]
Since September 2011, the Fed has managed to manage inflation expectations but not inflation itself. Has anyone noticed? What happens when they do? Will QE4 also succeed in altering even inflation expectations when QE1, QE2, Operation Twist and QE3 failed to prevent recorded inflation from now falling to 1.1%?
Russell Napier, strategist for CLSA, warns that benign inflation (s0 for stock market investors) is very close to reverting to dangerous deflation. (H / T at Air conditioner.)
It is worth paying attention to it, because the strategist with the historical mind has the form. Long stocks from mid-2009, he got the right valuation two years later when he said inflation would not take off, even though the call at the time to avoid the market was the wrong one. [Update: We’ve been reminded that there was a big element of right for the wrong reasons. Looking back, the 2009 call that Treasuries were the worst possible investment was, shall we say, premature.]
It is also this rare call that seems to make sense of the weird “bad news is good news” behavior that has been at the heart of the rise in equity values over the past two years.
The fall in inflation in the United States from over 4% to almost 1% has been largely benign, as the drug – interest rates close to zero, asset purchases by the central bank – has pushed prices higher. asset prices.
Today, however, Napier fears that inflation has fallen to 1.1% in the United States and 0.7% in the Eurozone, near a threshold from which the fear of deflation (and the stagnation that it implies) begins to dominate again.
Deflationary winds are strengthening. Japanese companies continue to reduce their selling prices in US dollars, forcing Chinese and Korean exporters to follow suit. Another significant drop in the yen would increase the pressure. Meanwhile, money supply growth remains sluggish in the developed world. In the United States, the Fed’s inability to create normal broad money supply growth intensifies as bank lending growth slows rapidly, while in the euro area bank lending to the private sector slows down. is now contracting faster than in 2009. The failure of monetary policy to overcome deflation is about to become evident, with dire consequences for stock prices
The lesson of the past, he argues, is that the three previous times the inflation rate in the United States has fallen below 1 percent since 1957 – 1998, 2001-02 and 2008-09 – stock investors have suffered significant losses.
The first two of these deserve careful consideration, as the sharp fall in inflation tends to be seen as a footnote reminiscent of the Asian crisis, the failure of genius, and the crisis that followed the bursting of the dot-com bubble and September 11.
The 1998 crisis now looks like a failure on the chart, but it represents an interesting time when stock prices fell 20% despite very robust real economic growth in the United States. The decline was triggered by fear of deflation, not inflation, with many speculating that credit defaults in Asian countries, Russia and perhaps LTCM would bring the US banking system to its knees.
In 2002, when Ben Bernanke was doing his infamous helicopter money speech, stocks fell nearly a third after US inflation fell below 1 percent.
Moreover, in 2008 inflation fell from that 1% line a few days before Lehman Brothers declared bankruptcy.
Obviously, there was a lot going on in each of these previous three time periods, and falling inflation should be seen as a sign of general stagnation, rather than the only data set on which it all rests. But it’s also worth noting that in each previous period, the threat of deflation has been immediately and aggressively fought by the Fed.
This time around, however, it’s a reminder that it’s not just the Fed’s ability to cut back on asset purchases that’s a risk. And as Matt King of Citi was arguing, many investors are half-heartedly optimistic, one foot definitely on the doorstep as central bank asset purchases begin to decline.
The three indicators to watch, according to CLSA, are a drop in the price of copper, a drop in the five-year inflation rate implied by the prices of inflation-protected Treasury securities (advice) below 1.5% (currently 1.7%) and higher corporate bond spreads. (Although the latter is not very predictive).
But the central message, given that the US market is now very far from cheap, is not to hang around if you don’t have to.
This analyst believes that inflation drops below 1% and that the party is over. You should leave as soon as possible. Those who insist on staying until the last minute should dance by the door. As the saying goes, “no one rings the bell at the bottom of the market”. Well, they don’t sound like “give up ship” at the top either.
Can we hurry and become negative already? – FT Alphaville
There is no easy escape from secular stagnation – List A
Tips-ta-geddon – FT Alphaville
Tips are the best – FT Alphaville
U.S. consumer price index drops for first time in six months – FT
Find the bottom of this bear market – FT Long-Court