09 May 2022
The price of second-hand cars in the US dropped by 3.8% month-on-month in March. Used cars have been a significant contributor to the surge in the US consumer price index (CPI) over the past 18 months, and a clear example of the disruptions caused by the pandemic.
While a single data point does not make a trend, this development supports our view that core inflation is peaking and that base effects will lead to lower pricing pressures in the coming months. This is welcome news for both consumers and the US Federal Reserve, which may be able to slow its tightening pace, making a soft landing more likely.
US real yields, as measured by 10-year Treasury inflation-protected securities (TIPS), turned positive, briefly, in April for the first time in two years. While still low by historical standards, positive real yields create a challenge to the market’s mantra that “There Is No Alternative” (TINA) to equities. It also suggests that monetary policies are becoming less supportive. In the grand scheme of things, negative real yield seems an anomaly. Returning to some form of normality should allow for a more rational approach to investing, both from companies and investors (institutional and individuals).
While core inflation appears to be peaking in the US, headline inflation (including energy and food costs) is still heading up. Food prices in particular have surged lately, fuelled by the disruptions caused by Russia’s invasion of Ukraine. Indeed, the latter is one of the main exporters of grain (mostly wheat) as well as vegetable oils. At the same time, increased gas prices have led to a sharp jump in fertiliser costs, making the conflict in Ukraine a global rather than a local issue when it comes to food production. Rising food costs will be mostly felt in the developing world. Egypt appears particularly vulnerable, as wheat represents more than a third of caloric intake per person and wheat imports (mostly from Ukraine and Russia) usually account for about 62% of total wheat use in the country1.
Despite all the noise, earnings expectations for 2022, at least as measured by the sell-side consensus, have been revised up since the beginning of the year. A big part of these positive revisions has come from the energy and basic resources sectors, which stand to benefit from the jump in commodity prices.
But even stripping out both sectors, the rest of the market has seen earnings expectations remaining broadly flat overall with only consumer discretionary and communication services seeing significant downgrades. One explanation could be that analysts are struggling to update their numbers given the ongoing uncertainty. The first-quarter earnings season is unlikely to provide much needed clarity, but we expect overall earnings to trend (marginally) lower soon.
Although it’s less the case nowadays, China remains the factory of the world. As such, it needs to consume (import) raw materials to export finished goods. It is also a superpower with a big (internal) appetite. It is therefore not surprising to see China’s trading activity and commodity prices move in tandem.
Yet, over the last few weeks an unusual decoupling has emerged. While Chinese imports grounded to a halt, likely reflecting the lockdown-driven drop in economic activity, commodity prices surged. This clearly illustrates that commodities aren’t becoming more expensive because of booming demand, but rather due to constrained supply. This divergence will likely reverse in coming months. The question is: will it be driven by an acceleration in China or a decline in commodity prices? In our view, it will be a bit of both.
Welcome to the May edition of "Market Perspectives". This month we take a look at the implications of elevated inflation for equities and bonds, how private markets can help you navigate rising inflation expectations, and what investors can do to protect their portfolios in the face of stock market turbulence.
