Monday, June 1, 2009

we think investors could be surprised by how long inflation remains subdued.

TO BE NOTED: From Alphaville:

JPM says mild inflation good for stocks too

Wading into the inflation vs deflation debate this Monday morning is JP Morgan with a whopping 37-page note.

Their central case is neither high inflation nor outright deflation, but a moderate “Goldilocks” bout of price increases — neither too hot not too cold.

Here’s JPM’s European equity strategists Mislav Matejka and Emmanuel Cau on the subject:
While most do not perceive inflation to be a near term risk anyway, we think investors could be surprised by how long inflation remains subdued.

JPM economists have a base case view of low inflation readings for an extended period of time, with 0% core CPI prints in the US in the middle of 2011, two years from now. In the other main regions our economists expect headline CPI to print between 0 and 2% over the next few years. …

The basic driver behind these relatively sanguine inflation forecasts is the size of the output gap the global economy currently displays. If the output gap analysis is still relevant, even if the economic activity manages to surprise on the upside over the next few years, it would still be difficult to arrive at meaningful rates of inflation growth.

Mild inflation, is, according to JP Morgan, supportive for stocks. Shares, they note, tend to perform best in the -3 per cent to 3 per cent inflation range. At higher levels of inflation (or deflation, for that matter) they tend to perform poorly as P/E multiples compress, according to the strategists.

To demonstrate that high inflation point, JPM has provided some nifty charts, with data stretching back to 1870. Here they are.

JPM - S&P 500 performance in different inflation

JPM - S&P 500 performance during periods of inflation above 5%

So the analysts conclude that the current environment of low inflation “could be seen as very supportive for equities from an inflation perspective, with low inflation in the near term, and a potential move higher thereafter.”

Looking at the second table, however, you might think — if you were expecting relatively high inflation (or even hyperinflation) at some stage — that stocks might not be your best bet right now. However, if you break-down Table 5 into seperate periods before and after the period of high inflation (bear with us) you get the following:

JPM - S&P 500 performance during and following inflation

So while stocks don’t necessarily perform very well directly during periods of high inflation, they do perform relatively well in the year before high inflation and immediately after — and of course, in periods of moderate inflation, according to JPM. In sum, if you are at all close to erring on the inflation-side — hyper, high or mild — you should probably be looking at stocks right now. Specifically, stocks like commodities companies and consumer staples, according to messrs Matejka and Cau .

Related links:
Taleb goes long inflation - FT Alphaville
Of bonds and stocks and the Weimar Republic - FT Alphaville
Marc Faber: Hyperinflation coming to the USA - FT Alphaville


Don the libertarian Democrat Jun 1 16:12
This is an excellent analysis. I understand the earlier comments, but, for Heaven's sake, none of us really know what's going to happen. The point is that, in its own terms, which I agree with, the analysis makes sense.

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