Thursday, April 10, 2014

Declining Misery Index Boosting P/E (excerpt)

Is “lowflation” good or bad for stocks? In her speech last week, IMF Managing Director Christine Lagarde warned that inflation might be too low: “There is the emerging risk of what I call ‘lowflation,’ particularly in the Euro Area. A potentially prolonged period of low inflation can suppress demand and output--and suppress growth and jobs.” That sounds like a bearish environment for stocks. However, she then said that the solution is “[m]ore monetary easing, including unconventional measures…” Her advice was directed particularly at the ECB.

More ultra-easy monetary policies from the world’s major central banks in response to lowflation is bullish for assets in general and stocks in particular. In the past, there has been an inverse correlation between inflation, as measured by the core personal consumption expenditures deflator (PCED), and the forward P/E of the S&P 500. Most recently, the P/E rose from a low of 10.4 during August 2011 to 15.5 last month. Over that same period, the PCED inflation rate, on a y/y basis, fell from 1.6% to 1.1%.

An even better fit is between the P/E and the Misery Index, which is the sum of the inflation rate and the unemployment rate. Since the 2011 low in the P/E, the Misery Index has declined from 10.6% to 7.8%.

Lowflation is bullish because the Fed is much less likely to tighten as long as it persists. While Fed Chair Janet Yellen caused a stir recently by suggesting that the FOMC might start raising interest rates six months after QE is terminated at the end of this year, she also said it depends on whether inflation rebounds back to 2%.

Today's Morning Briefing: Lowflation. (1) IMF chief warns about “lowflation.” (2) P/E inversely correlated with inflation and Misery Index. (3) Central bankers are macroeconomists blindly following the “slack” model. (4) What if globalization, technology, cheap money, and competition are driving lowflation towards deflation? (5) Any signs of deflation in revenues, margins, and earnings? (6) A whole bunch of global forward earnings comparisons. (7) Focus on underweight-rated S&P 500 Materials. (More forr subscribers.)

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