Has inflation peaked?

Has inflation peaked?

Share it

The environment is different from that of the past decade, but not to the point of questioning fundamental analysis, the spirit of prospecting and contrarian decision-making as means of generating returns.

The inflation problem

Politicians face a complex challenge to control extreme inflation, without wanting to drag the world economy into a deep recession. This is a difficult balance to achieve. While the natural tendency for central banks has been to relax their tightening policy in times of heightened uncertainty, the ability to override price volatility is limited due to the inflationary boost that has emerged as the global economy was emerging from the worst demand conditions of COVID, without supply chains otherwise normalizing.

Due to these abnormal demand and supply conditions, inflation disrupts economies, consumers, businesses and investors. The origin of inflation, which is at multi-decade highs, can be described as crisis (war) following crisis (a global pandemic that has restricted normal supply chains), creating crisis of confidence fueled by unstable and rising prices.

With central bankers and investors both adjusting to a sudden spike in extreme price increases, the question on the minds of many equity investors is when and how does inflation peak and at what level? The parallel question is what will the world look like in terms of economic and corporate earnings growth when that happens, given that these are two key performance drivers for equity markets? , valuations being a third?

Why would inflation fade?

Although the world remains very uncertain, we are beginning to see the impact of price increases on consumption, both real and implicit. While consumer balance sheets are strong after two years of COVID disruptions and employment levels remain high, there are clear signals that consumers are adjusting their spending habits as inflation hits. This demand destruction is part of the mechanism by which inflation will peak and subside as the economy slows.

There are also several examples of companies adjusting their personnel policies as the economic outlook eases. A key driver of this inflation cycle has been wage growth, as a strong economy faced tight labor markets. With companies from Amazon to Uber now acknowledging the changing economic outlook and the need for better cost control, the second half of 2022 will reveal a key data set around inflation forecasts.

In short, although we cannot predict the exact timing of the reversal of inflation, we feel we are closer to the peak of inflation than the early stages of a cycle of rising inflation. Likewise, it is difficult to estimate the extent to which economic activity is waning due to the tightening, uncertainty and high prices. However, the solidity of the balance sheets, the absence of systematic risk and the conviction that the Fed wants to avoid a deep recession encourage us not to join those who call for an economic crisis.

What does inflation mean for growth investors?

If there is a silver lining, in a year dominated by bad news, capital markets have already priced in a modest recession with a strong sell-off in growth stocks. It hasn’t been easy, but much of the shift in capital to growth stocks is now complete, which calls into question the growth stock category, but more importantly stock selection within the actions in the broad sense. Once inflation peaks, it will be a good signal for investors and especially for companies able to dial in and grow their earnings in the next stage of the cycle.

Outlook for this year

At the end of the year, the solidity of corporate balance sheets could constitute a lever for the return on capital. As stock markets recover, it’s good to remember the importance of fundamental analysis. This is not to make a call for growth, or a call for value, but to understand the leveling of the investment playing field after a period defined by very narrow market leadership.

The second half of 2022 is therefore set for a battle between those who believe the bad news has already peaked and those who believe in a deep recession. We are in the first group and maintain that pockets of growth will emerge in a world where growth conditions are tightening. We believe that the prospects for improved economic returns, at the stock level, are a valuable source of return throughout a market cycle, but even more so in a world where overall growth is limited.

Corporate earnings will continue to be the focus of intense attention, given the real support they have given equities over the past decade and in the post-pandemic era. Firms that can absorb inflationary pressure while providing economically relevant products to a harder-to-please set of consumers will be fewer in the next stage of the cycle. Companies whose economic performance is improving and those that can compound returns in more challenging environments will be in demand.

Conclusion

The outlook remains uncertain. There’s no doubt about it, but our theory remains one of modest growth (which is different from a global recession) and falling inflation (which is different from a cycle of runaway inflation). The environment is clearly different from that of the past decade, but not to the point of questioning fundamental analysis, the spirit of prospecting and contrarian decision-making as means of generating returns.

#inflation #peaked


Share it