Multi-asset
Inflation is temporary but the rotation is not
In the latest instalment of Simply Put, where we make macro calls with a multi-asset perspective, we explain why higher inflation will be temporary and why this should further fuel the rotation from value into growth.
Need to know
|
---|
The “transient” or “temporary” nature of the current inflation shock, seemingly prevalent in 2021, is now being challenged from several angles. First, the numbers themselves: inflation is high and persistently so. Second, market pricing and economists’ forecasts show only a slow decline in inflation during the quarters to come. Third, it is now a political issue. This is most notable in the US. During the Senate hearing regarding Lael Brainard becoming a member of the Federal Reserve’s (Fed) board, the Fed’s inaction was repeatedly labelled a “mistake”. As detailed in last week’s edition, the current inflation surge reflects fiscal policy: so in the case of the US the arsonists are simply blaming the firefighters. Now, against a backdrop of a market rotation to value from growth, this question seems to be even more crucial. In our view, inflation will be temporary but the rotation is set to continue.
Inflation will be temporary, but it is just a bit more persistent than initially thought. Many economists suggested inflation would be temporary because it reflected a disruption of the supply chain caused by pandemic-induced lockdowns and health measures. Today, cargo shipment data mostly show levels never seen before: producers and delivery systems are working at full steam with full capacities. Yet, inflation remains stubbornly high: (as discussed last week) today inflation empirically reflects the intensity of economic growth. If not, how can we explain why price growth for comparable products is so different between the US, the Eurozone, Switzerland and China? Local demand determines local inflation, while inputs costs are the same for everybody – with a caveat for the impact of forex. Demand is now in the driving seat as far as inflation is concerned.
Chart 1: Rebased evolution of US disposable income (left) and US savings as a ratio to GDP (right)
Source: Bloomberg, LOIM
Two factors typically make demand tick: income and wealth:
- Wealth remains high, particularly in the AngloSaxon world. It has been driven by fiscal spending and the skyrocketing stock market. Despite these factors, savings in the US have stopped outpacing GDP growth as shown in chart 1 (right-hand chart). The ratio is now lower than it was in June 2020. The current decline in the stock market should add to this phenomenon as “retail money” is predominantly invested in the tech sector.
- Meanwhile, wage growth has increased worldwide and has not kept pace with inflation. This has led real wages to contract. As illustrated by chart 1 (lefthand chart), since the fiscal stimulus of Q2 2021, real disposable income (one of many proxies for real wage growth) has declined each quarter. In total, real wages are now just 2.6% above their pre-pandemic level. This means inflation has normalised the action undertaken by governments and eaten into wages and wealth quite rapidly. With another year of inflation exceeding wages by 2% in the US, consumers will have to dip into their savings to maintain their standards of living. We will be keeping an eye on bank deposits to see how quickly they melt away.
Adding these factors to the tighter monetary policy, which has now become a political necessity, and you can see a combination of factors that will slow world growth, particularly for the US economy. This should extinguish the sparks of inflation in the fire. In other words, farewell demand.
This could be essential to understanding the sector rotation currently at play in equities. As shown in chart 2, the relative performance between value and growth stocks (using the MSCI World indices) almost perfectly tracks the evolution of the US 10-year real rate. If inflation slows more rapidly than expected in 2022, will the ongoing rotation from growth to value end? We do not think so. Real rates have declined for two reasons: first, and foremost, due to the large amount of savings accumulated during the pandemic and second because of central banks’ accommodative policies. There is little doubt that this second factor has now turned. However, the first factor is also starting to change course. Inflation and the recent decline in growth stocks will hit savings further, fuelling the normalisation in real rates which should let the value rotation unfold.
Chart 2 – MSCI value versus MSCI growth versus US 10-year real rates
Source: Bloomberg, LOIM
Simply put, inflation will be temporary because wages are lagging and central banks will fight against this. The rotation into value equities should continue as real rates normalise. Welcome to the post-pandemic world and the normalisation of its excesses. |
---|
Nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick.
These indicators currently point to:
- Solid growth worldwide, with stronger momentum in the Eurozone, while China lags. US growth momentum is showing tremors of moderation.
- Inflation surprises are more likely to be positive but could also lose momentum across the three zones. The pace of inflation pressure moderation has gained momentum lately.
- Monetary policy is set to remain on the hawkish side, except in China. Our nowcasting indicator for the US and the Eurozone remains in high territory.
World growth nowcaster
World inflation nowcaster
World monetary policy nowcaster
Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
important information.
For professional investor use only
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name.
This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorized and regulated by the FCA. ©2022 Lombard Odier IM. All rights reserved.