The Only Thing More Bullish Than Inflation Is….

Deflation. And not just deflation, but a deflationary bust! At least, such is the goalseeked logic of Cornerstone Marco, which has released a bullish (no really) note titled the Coming Deflationary Boom in the U.S.

In it the authors throw in the towel on the most conventional concept in modern economics, namely that for growth one needs stable inflation which in turn causes earnings growth and is low enough not to pressure multiples too high. Well, according to the BLS’ hedonic adjustments and courtesy of Japan’s epic exporting of deflation, inflation is nowhere to be seen (except if one eats pork or beef, or drinks milks), so it is time to give ye olde paragidm shift a try. The paradigm that the only thing more bullish for stocks than inflation, is deflation.

To wit:

The concept of a deflationary boom is a controversial one in economics. Truth be told it will not work in every economy. Indeed, a prerequisite for this to unfold is an economy driven by consumers. In that sense, it does not get more consumer-centric than the US. The second, and necessary, condition calls for a major decline in commodity prices ideally compounded by a strong currency to provide the fuel for growth. In essence, a decline in commodity and import prices creates disposable income the same way the Fed Funds rate cuts used to a decade ago.

Positioning for a deflationary boom is a binary event. After all, “deflationary” implies that stocks levered to lower inflation will have a powerful tailwind, these are what we like to call early cyclicals such as consumer, transports and other similar segments. Meanwhile, the “boom” part of the story implies that segments levered to growth, US growth in this case, also find a tailwinds. This should help the beleaguered financials to a better year in 2015 and also provides support for sectors like technology and some of the industrials. As we see it, “deflation” is going to become the operative word on the street … that and PE expansion since they typically go hand in hand. As always, we shall see.

Indeed we shall. Then again the only thing we will see is how every time there is deflation somewhere in the world, one after another central bank somewhere will admit its only mandate is to keep stocks at record highs and inject a few trillion in risk-purchasing power into what was once called a market.

One thing the authors do get right that the only benefit resulting from ever more liquidity is P/E (and make sure that is non-GAAP E post buybacls) multiples that are stretched several sigmas wider than anything seen in recent history, especially if one looks at GAAP EPS which at last check were just shy of 20x.

So to summarize:

In an “Inflationary” world, EPS growth that drives equity upside.
In a “Deflationary Bust“, the unprecedented multiple expansion that not only offsets declining EPS but leads to even recorder equity highs.

Rinse, repeat, because you just can’t lose!

And for the idiots in the audience, here is Cornerstone’s infographic for dummies which shows that no matter what happens in the world, stocks can only go higher!