In the March issue we discuss: 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?
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Reflation continues to drive the equity rally
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 3.5% 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 7.8% year-to-date gain, with UK stocks lagging their global peers slightly on 3.7%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. However, with a third of the population already having received their 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 for National Statistics reports that 41% of those aged over 80-plus tested positive for coronavirus antibodies in England3.
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.
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.
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, materials 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.
Implications and risks from rapid money supply growth
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 was never likely to attract headlines, but it 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. The reasons for this expansion are clear: the fiscal and monetary policies pursued by the US government has boosted citizens’ bank accounts as well as bank lending and has led to a multiplier effect of more money flowing through the financial system which in turn should drive-up economic growth.
However, greater money flows into the financial system also comes 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 – see Market Highlights opposite on GameStop.
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
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.