It’s a nominal world
Whilst the current bout of inflation (energy-related) is similar to the early 1970s there are distinctive differences between now and then. However, it is worth noting that even during the 1970s, US corporate profits grew at a similar pace as the nominal economy, and strongly outpaced real economic growth.
In the 1970’s corporate profits tracked nominal economic growth, so whilst the mix of inflation and growth isn’t ideal in terms of economic living standards, corporate profits can continue to grow in a period of stagflation (Index = 100 1970).
Source: Bloomberg, Artorius
Central Bank Quandary
Central banks’ policy responses to higher inflation and the subsequent implications for economies will be key for markets over our investment horizon. Even before the acceleration in commodity prices, rising inflation meant central banks were either starting or discussing monetary policy tightening. While the war in Ukraine has increased economic and financial uncertainty particularly in Europe, policymakers have been consistent in their focus on inflation and have guided that policy normalisation remains the key priority.
Recent comments from officials at the US Federal Reserve indicate that interest rates will be increased through the rest of 2022. Currently this stance appears to be justified as the pace of economic growth continues to be robust and the labour market remains tight. Interest rates are expected to increase to 3% in 2023 from 0.25% currently.
In the UK, the market is pricing in that interest rates will rise from 0.75% to 2.5% in the next 12 months. Last week’s retail sales numbers suggest that cost-of-living issues are already starting to impact economic growth. We would suggest that the Bank of England may regret policy tightening into a period of falling real incomes. If further weakness emerges in the UK economy, which we believe is likely, then markets may reassess the need for monetary policy action and sterling may weaken.
“When the Fed pushes the brakes, someone goes through the windshield.”
Joseph Amato, Chief Investment Officer for equities at Neuberger
How hard the Federal Reserve and other policy makers push on the brakes will determine the need for investors to be wearing seat belts. Casualties in investment A&E include highly valued stocks (think profitless tech companies). Avoiding a recession will be necessary to avoid a long line of ambulances.