Markets Update: Inflation and Equities

Global Macroeconomic Shift: Move from Deflation to Reflation

• Goldman Sachs forecasts a shift to a "more reflationary environment" characterized by synchronized global growth, contrasting with the deflationary trends of the post-2009 era.
• Real GDP growth is projected at 6.5% for the current year, rising to over 4.5% in the subsequent year, marking the strongest synchronized local growth in approximately 30 years.
• Monetary conditions remain historically loose, with economists expecting policy rates to stay at zero until at least the second half of 2014, resulting in negative real interest rates.
• The US is anticipating a new $1.5 trillion fiscal program, adding 6.8% of GDP to the previous $900 billion approved late the prior year.
• Long-term capital investment in decarbonization-led physical infrastructure is estimated at $16 trillion over the next two decades.

Equity Market Implications and Flows

• A transition from deflation to reflation is viewed as positive for equities, as deflation historically favors nominal risk-free assets like government bonds while growth recovery supports real assets.
• Net flows into global equity funds reached a record $60 billion in the last week, with inflows scaling to the 96th percentile of historical assets.
• Corporate profit growth is forecast to rise by approximately 35% globally for major stock markets, followed by double-digit growth in 2022.
• The resumption of dividend growth alongside profitability recovery is expected to make equities more attractive relative to fixed income, where bond yields are near record lows or negative.

Sector Performance and Relative Value Opportunities

• Value vs. Growth: Value stocks (mature industries, lower valuations) are expected to outperform growth stocks as rising commodity prices and stronger growth prospects correct the market bifurcation seen since the financial crisis.
• Cyclicals vs. Defensives: Cyclically sensitive sectors (basic resources, chemicals, industrials, oil, financials, building materials) are projected to outperform defensive industries due to higher operational leverage during economic recovery.
• Banks: European banks have recently beaten earnings consensus by approximately 27%, with nearly 80% surpassing expectations by more than 5%, signaling a turnaround from a decade of underperformance.
• Volatility: Low-volatility strategies that dominated the post-crisis era are expected to lose favor as investor confidence rises, potentially driving capital toward riskier, more volatile market segments.
• Dividends: Dividend yields are projected to decline as payments increase, improving relative equity valuations and restoring investor confidence after a decade of flat yields amid falling bond yields (US 10-year yields dropping from ~4% pre-2008 to ~1%).