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Five charts that matter for investors

10 October 2022

Julien Lafargue, CFA, London UK, Chief Market Strategist; Nikola Vasiljevic, Head of Quantitative Strategy, Zurich, Switzerland

Surge in US shelter costs set to moderate

To assess the severity of inflationary pressures, investors often look at the stickier components of the inflation basket. One of the largest and most relevant is shelter. It measures the costs associated with housing (not including investments and upgrades) and makes up 30% of the consumer price index (CPI). It’s sticky because once rent rises, it rarely comes down (similar to wages).

In August, shelter costs were up 6.2% year-on-year in the US (see chart), contributing significantly to the 8.3% increase in the headline CPI. Yet, things may be about to improve on that front. Indeed, the “rent index” published by real estate marketplace Zillow has been steadily declining since March. While the correlation between this index and the shelter component of the CPI has weakened significantly during the COVID-19 pandemic, it’s reasonable to assume that it still indicates what may lay ahead, not only for shelter costs but also for overall inflation.

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The performance of Zillow’s leading rent indicator and the urban consumers shelter component of CPI since 2017 suggests that shelter costs are about to fall

China’s influence on the euro

The euro has been under much pressure this year. The war in Ukraine and relative dovishness of the European Central Bank are often cited as primary reasons behind the free fall in the single currency. While these factors matter, we believe that the influence of China shouldn’t be ignored. More specifically, it appears that the euro/US dollar pair is moving in tandem with China’s credit impulse (see chart).

In other words, the more China stimulates its economy, the more the euro appreciates. This makes sense, given that the eurozone and the country are key trading partners. It’s also encouraging for the single currency, as we continue to believe that the Chinese government will ease monetary and fiscal policies further going into next year. This, combined with a more aggressive central bank and easing tensions around energy supply as we enter the spring, could leave the euro well positioned in the first half of 2023.

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The link between China’s credit impulse and the euro’s exchange rate against the dollar has been significant in the last decade

US consumers are still paying their bills

Many central banks are hiking interest rates in a bid to tame demand, and consequently inflation. This strategy is usually particularly effective in an economy where debt is used to finance consumption. The US is a prime example of this, with private debt to gross domestic product running above 150% and more than $1.1 trillion in outstanding revolving credit. In this context, higher interest rates raise the spectre of higher delinquencies and defaults, especially when the economic momentum is weakening.

On that front, the data is still supportive. According to consumer credit reporting agency TransUnion, car loans, credit cards, and mortgage delinquencies in America only ticked up marginally in the 12 months to July (see chart), despite difficult comparables (recall that the last US government-back stimulus cheque was issued in March 2021). Importantly, the proportion of delinquencies remains below pre-pandemic levels. Yet, this is a trend worth watching as a significant jump in late payments could have significant negative repercussions.

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The relatively limited increase in auto loans, credit cards, and mortgage delinquencies in the 12 months to July is an encouraging sign for the health of the US economy

A strong dollar isn’t deflationary this time

If one asset has defied gravity this year it is the US dollar. This can be explained by a combination of the differential in interest rates, safe-haven flows, and overall economic strength, which all favour the greenback. Historically, dollar strength and inflationary impulses have been tightly correlated (see chart). One explanation is that as economic activity slows, investors favour the safe-haven status of the dollar and demand for commodities dwindles.

This time around, though, dollar strength and the price of raw materials have become disentangled, weakening the disinflationary impulse. This is primarily due to idiosyncratic issues at play, including widespread shortages and the economic effects of the war in Ukraine. A more constructive and less uncertain outlook could prompt dollar weakness, while propping up commodity prices and boosting the inflationary impulse. 

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The link between the US dollar trade-weighted exchange rate and global export prices has been close since 2014

Sustainability is still gathering momentum

After being a key topic of discussion before and during the pandemic, sustainable investing has been less of a focus recently. Although the war in Ukraine has highlighted the need for many countries to find alternative (and domestic) sources of energy, inflation and the risk of recession appear to be bigger concerns for investors at the moment. The fact that many countries have had to rely on more fossil fuels to make up for their energy supply shortfall also contributed to making sustainability less of an issue, at least in the short term.

This perception appears to be largely removed from reality though. In fact, according to investment researcher Morningstar, funds labelled as “sustainable” have seen continued inflows this year in the UK. On the other hand, “non-sustainable” portfolios have experienced outflows in each of the last twelve months. While part of these flows could reflect the increasing number of ESG-conscious funds, this trend also suggests that the move towards sustainable investing remains alive and well.

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Estimated monthly and cumulative net flow to UK sustainable or non-sustainable, based on the prospectus, equity funds

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Market Perspectives October 2022

As bond yields zoom up, central banks get more serious on rate hikes, and recession risks become real, the mood in financial markets is glum. This month’s report attempts to put these short-term moves into context, providing insight and reasons why the longer-term picture looks more encouraging.

In addition to our usual asset class and financial market analysis, you’ll find our sustainability section, where we take a look at how beefed-up regulations may reduce “greenwashing” risk, and help to add value to a portfolio.

Market Perspectives

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