The following paragraphs get to the heart of why deflation is the current concern among market participants…
First things first, why deflation means disaster for global stocks…
When the Fed shoots for a stable inflation rate, it not only represents a sweet spot for a healthy economy, it also represents a sweet spot for investor’s long-term favorite asset class: stocks.
As reflected in this chart, P/E ratios (stock prices/earnings) increase when the inflation rate trends toward price stability (near 1% inflation), and P/E ratios decline when the inflation rate trends away from price stability. The result is a “Y Curve” effect, where P/E declines into deflation despite low interest rates.
So why the concern about deflation…
Because it’s appearing in three of the largest economies.
Japan
Confirming Abenomics 1.0 was a failure, Japan just returned to deflation for the first time since ’13.
Europe
The September CPI not only confirmed the inflationary impulse from the launch of QE is officially over, it confirmed that deflation has now hit the economic zone.
Is it just a matter of time before Japan and Europe start QE again?
US
Deflation has now seeped into the underlying economy with price action not seen since the Great Recession.
Import prices have declined by -11.4% year-over-year, which is the largest decline since Sept. ’09.
This decline is the largest on record outside of the financial crisis.
Excluding fuels, import prices have declined by over 3%, the largest decline since Oct. ’09.
Import prices excluding petroleum products are down- 3.2% YoY.
Deflation has hit both imported and exported consumer goods prices excluding autos.
Imported consumer goods ex-auto prices have declined at a -1.2% YoY rate.
Greater than the largest year-over-year declines we saw in ’09.
Export prices of consumer goods ex-autos are in a free fall at -2.86% year-over-year.
Never on record have export prices declined at this pace.
So why are stocks higher, do you ask?
Could it be that market participants know that central banks have no other choice but to start QE again?…and they now anticipate it!