Is there an alternative to reflation and a renaissance in earnings?

Last week was all about the reflation trade, which was expressed across all asset classes with equities, and especially emerging market equities, rising together with commodities while interest rates surged higher. Over the weekend, China released its producer price index for December beating expectations showing a -0.4% y/y change, which is the highest level since February 2020 and showing that prices on consumer goods produced out of China is rising. When we get to March and April numbers will begin to see the base effects from the big economic contraction last year. While some are beginning to question the reflation trade and whether the markets have gone too far, our view is that we have just started. However, there is no alternative to the reflation trade from a policy perspective as it would leave the economy stagnant and potentially in a deflationary stagnation amplified by high debt levels.

Stagnating earnings need to get back fast

The chart below shows the 12-month rolling earnings per share in the MSCI World Index showing earnings are down 29% in 2020 for global companies. While earnings have begun to recover for the S&P 500 Index due to it larger share of technology companies the rest of the world has not shown a rebound yet making the Q4 2020 earnings season even more important for sustaining buoyant equity markets. The negative impact on employment and corporate earnings from the Covid-19 pandemic have shifted global policy away from that of forward guidance to that of goal-based policies, which means that accommodative fiscal and monetary policies will be in place until we recover employment and earnings. As a result, we expect massive fiscal stimulus from every major economy to be announced this year, which will fuel the reflation trade as successful vaccine rollouts will help normalize the economy unleashing the huge private savings that have been accumulated during the pandemic.