The Strategist

Disinflationary headwinds?

The year 2023 holds many challenges for investors. By far the biggest is likely to be the divergence between the real economy and equity markets. 

Thomas Wille
Tempo di lettura
10 minuto
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The Nasdaq technology index has had extremely strong six months on the back of the artificial intelligence (AI) hype. At the same time, it has been difficult seven months in particular for bears who have stuck to fundamental analysis and not taken into account behavioural economic factors, positioning or market technicals. Defensive positioning has been offset, or at least cushioned, by exciting investment themes such as AI and reshoring.

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Profit recession - just postponed?

Despite high inflation rates in the Western world and the resulting pressure on corporate margins, the feared profit recession in the US and Europe as previously seen following the implosion of the dotcom bubble and the great financial crisis has not materialised. This is mainly because corporate sales growth tends to correlate very closely with nominal economic growth. In the US, for example, nominal economic growth will be between 4 and 5 per cent in 2023 as a whole, depending on the inflation rate. This is roughly equivalent to the US having a real potential growth rate of 2 per cent with an inflation rate of 2 per cent.

In the current economic environment, it is clear that not all companies will be able to pass on price increases to their customers, leading to a sharp decline in margins and profits. This is also the main reason why we have focused on stock selection and less on tactical asset allocation (TAA) since spring 2023.

Investors now expect that we will soon return to a disinflationary environment. Two-year inflation expectations are between 2 and 2.5 per cent in both the US and the eurozone. In the past, a disinflationary environment has been accompanied by solid earnings growth. This time may be different as real GDP growth is close to zero. As a result, nominal growth, and hence corporate earnings growth, will come under pressure as inflation falls. The expected disinflationary environment could act as a headwind, at least in the short term, and the probability of continued weak earnings growth has increased. However, this scenario is not sufficient for an earnings recession.

S&P 500 multinationals

Beyond the potential disinflationary headwinds, there are significant tailwinds for some US companies. In particular, multinationals with high foreign currency sales will benefit from the weak US dollar in the second half of the year. Since the third and fourth quarters of 2022, the dollar depreciated by a whopping 7 per cent. Stock-picking remains in the focus.