From Andrew Garthwaite and team at Credit Suisse (bold statements from the strategist):
« We put a 10-20% chance on Japanese-style deflation in Europe: We believe deflation is not falling CPI, but falling wages and falling property prices.
In Japan, wages fell in 1997 largely because it was (and remains) twice as hard to fire workers than in the euro area, and hence to reduce labour costs salaries had to fall. With wages in the euro area rising by 1.5% currently, the decline in CPI boosts real disposable income. In Japan, property prices fell 80%, whereas they fell 6% in Europe, and in many countries are now rising (and property appears affordable). Additionally, corporate leverage in Japan was 50% higher when deflation began than it is in the euro area today. Policy is much better: in Japan’s case, banks were not adequately recapitalised until 7-11 years after CPI went negative; in Europe, banks’ assets have fallen 12% but have stabilised; the BoJ started to print money 6 years after hitting deflation (compared to the ECB doing so while inflation is still positive).
REERs in the periphery have largely corrected (implying the end of deflation).
European demographics are also much better than those of Japan.
■ We think deflation would occur only if both: (i) China had a hard landing (i.e. property prices fell 20% or more); and (ii) the ECB did not expand their balance sheet. We continue to believe that conventional QE in the euro area is likely at the turn of the year.
■ What if deflation occurs? The best performing sectors would likely be pharma, food producers, retailing, utilities and telecoms, while the worst would be banks and mining. In this scenario, we would recommend non-cyclical companies with low financial leverage (e.g. Sanofi, L’Oreal, Telefonica and Total) and quality growth stocks (e.g. Coloplast, Assa Abloy and Sonova).
■ Cyclicals are pricing in too much growth pessimism: We think cyclicals are pricing in a fall in IFO of c.4 points. Price, forward P/E and P/B relatives are all close to their post-2009 lows, as is hedge fund positioning. We would highlight software and corporate spend-exposed areas. »