Reflation continues to drive the equity rally | March 2021



In this episode we look at how the growth in money supply in the US could impact the global economy looking forward. US broad M2 money supply increased by 27.5% in January 2021 from a year ago, the fastest growth rate in 150 years. What does this mean for equity valuations?

Let’s start by talking about what’s happened in stock markets in February: has the rally continued?

Following the global peak of new coronavirus cases in January, equities continued to rally from their March 2020 lows. So far this year, the MSCI All Country equity index total return (including dividends) is up 4.5% in local currency terms, as optimism grows on a global economic recovery1.

By geography, emerging markets equities (particularly Asia) have led the way, registering a 6.6% year-to-date gain, with UK stocks lagging their global peers on 2.6%2. Arguably, UK stocks may have been held back due to uncertainty from trade friction in a post-Brexit world and an out-break of COVID-19 mutations.

Do you see better times ahead for the UK?

Yes. Around a third of the population has received its first dose, there are signs that the vaccine is beginning to immunise some of the most vulnerable parts of society against the pandemic. In a survey taken over the 28 days to 1 February, the UK Office of National Statistics reports that 41% of those aged over 80-plus tested positive for coronavirus antibodies3. Now that PM Boris Johnson has laid out a road map to open-up the UK economy, the probability that the economy and company earnings can rebound in 2021 after sharp declines in 2020 has increased. This creates an opportunity for domestically-orientated UK stocks to outperform in the coming months.

What signs are you seeing in the broader global economy?

The rally in stocks has also broadened to other financial indicators that reflect strengthening economic activity (i.e. reflation). For instance, since the March equity low last year there have been sharp price rises in commodities (raw materials), including copper (104.5%), aluminium (93%), corn (71.8%) and crude oil (146.5%)4. Some of the underlying drivers for a sustainable upturn in commodities are falling into place. These include moving towards the end of lockdowns, fiscal infrastructure plans and an improvement in US-China trade relations under the Biden administration.

Let’s talk about commodities and the implications for inflation. It’s been quite a good period for commodities as I understand it…

Environmental policies have given an added boost for commodities. A secular demand shift towards electric vehicles is creating strong demand for copper, which is now trading at a 10-year high. For instance, a battery-powered electric car typically uses around four times as much copper in its weight than a petrol or diesel equivalent. Additionally, with the US re-joining the Paris climate accord and the cancellation of the Keystone XL pipeline in America, capital investment in fossil fuels faces material headwinds. A subsequent tightening in energy supply is likely to put upward pressure on crude oil prices and backstop the reflation trade.

Looking forward, we see a favourable backdrop of support for reflation beneficiaries, such as; i) equities over bonds; ii) energy, material and industrials in the value sector over high-growth technology, at least in the near term; and iii) non-US equities like emerging markets and the UK.

OK, let’s turn our attention to money supply, which has been growing rapidly.

Yes, while global attention has been focused on the coronavirus vaccine, Brexit and a new president in the US, the growth in money supply in the US is also important to the global economy.

US broad M2 money supply increased by 27.5% in January 2021 from a year ago5. This measure includes bank current accounts, savings accounts (household and corporate) and the monetary base (i.e. the Federal Reserve’s balance sheet). To put this in context, it is the fastest growth rate in 150 years and even surpasses that seen in the 1940s when the US was ramping up war production.

And why has that happened?

The reasons for this expansion are clear: the fiscal and monetary policies pursued by the US government in the wake of the pandemic have pushed up money supply. The government has provided cheques to its citizens, for which the Fed has provided financing. Stimulus cheques are going into bank accounts, which in turn pushes up money supply. Banks are lending money, which has ended up in deposits, also increasing money supply. With more money flowing into the financial system, the fuel is there to drive-up economic growth and stocks.

What does it mean for the financial system?

Greater money flows into the financial system come with risks. Recently, retail traders have taken advantage of easy access to money and low rates to leverage up their investments. Excluding what investors hold as cash and profits from previous trades, US net margin debt stands at a record $333bn6. By borrowing money at the “margin”, this can lead to significant market dislocation, where equity prices move far away from their underlying future earnings potential.

Moreover, traditional valuation metrics like the Price-to-Earnings ratio (PE) have also been inflated by an expansion in central bank balance sheets and money supply. While there can be little doubt that such valuation metrics are at historically elevated levels for equity markets, notably in the US, this should be considered in the context of historically low (unattractive) bond yields. Valuation metrics are also often poor market timing tools; they can become more stretched over long periods leading overly cautious investors to miss out. Considering that the consensus of analysts forecast strong global Earnings Per Share growth of nearly 29% for 2021 and a further 15% in 2022, valuation multiples can continue to expand to even higher levels to capture the positive company earnings backdrop and supportive money supply growth7.



1, 2, 4, 5, 7 Refinitiv Datastream, data as at 26 February 2021

3 ONS coronavirus COVID19 antibody data for the UK, data as at 21 February 2021

6 FINRA Margin Statistics, data as at 1 February 2021


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This episode was recorded on  02/03/2021

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The Pulse from Smith & Williamson

Investment Show: Reflation continues to drive the equity rally

Episode 19

Broadcast on Smith & Williamson at 09:00, 7th of March 2021

Available online from 10:00 on the same day .

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