Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Is there an alternative to reflation and a renaissance in earnings?
Peter Garnry
Chief Investment Strategist
Summary: In today's equity update we take a look at earnings in the MSCI World down 29% in 2020 and why the reflation trade has just started as policy makers have moved to a goal-based policy of providing stimulus until employment and earnings are back to levels from before the pandemic. This will drive higher interest rates, inflation, earnings and the rotation out of technology stocks and into value stocks. We also take a look at the Q4 2020 earnings season which starts this week with the most important earnings coming on Friday from major US banks.
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.
The reflation trade was also reflected in the S&P 500 dividend futures Dec22 rising 5.2% reducing the drawdown since late 2019 to only 8%. This is the best market indicator on the impact from stimulus and vaccine rollout. The stimulus provided so far on top of expectations from Biden’s upcoming stimulus have so far almost closed the growth gap to 2022. If the vaccine rollouts go as we expect then the gap will be closed by Q2 2021 and then the cumulative impact from everything done on the policy side will kick the reflation into gear in the 2H 2021 causing the inflation rate and interest rates to go higher. We are unsure on the impact on technology stocks, although as we have communicated lately, we do expect value and commodity sector stocks to outperform. We have the Nasdaq 100 interest rate sensitivity at around 15% for the first 100 basis points, so aggressive overweight of US technology stocks should be revised throughout 2021.
The Q4 2020 earnings season starts this week
The first week of the earnings season is always light on earnings releases. This we will get earnings from the following companies in the S&P 500 and STOXX 600 indices.
- Monday: Carnival
- Tuesday: Games Workshop Group
- Thursday: BlackRock, First Republic Bank, Delta Air Lines, Chr Hansen
- Friday: Charles Schwab, PNC Financial Services, JPMorgan Chase, Citigroup, Wells Fargo
While earnings from Carnival today and Delta Air Lines on Thursday will give a good insight into the rebound in these hard hit companies due to mobility restrictions, the real insight will come from the major US banks reporting on Friday. They will provide an update on the credit developments in the US private sector while providing an outlook for broader US economy. We expect the investment banking divisions driven by trading activity to have been very strong lifting earnings in Q4.
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