Inflation expectations are changing, equities are still too hesitant to react.
Chart of the week
The chart shows inflation (CPI, Consumer Price Index) in the euro area. The blue line shows the total inflation figure and the black line only inflation excluding the volatile elements of energy and food. The black line is then also referred to as the main inflation (core inflation).
Why this is important
Inflation is going down, but currently only the volatile components energy and food. The same can be seen in the USA.
The chart shows the individual components of inflation in the USA: rent, services, food, raw materials and energy. Again, the picture is the same; inflation from commodities and energy are declining, but the remaining inflation drivers are rising steadily.
The two inflation components, rent and services, are often referred to as sticky inflation. They are mostly rising but rarely falling.
The picture is worrying because it shows that the central banks have not yet got a grip on inflation. They will have to raise key interest rates further.
Inflation expectations are changing
The chart shows the number of interest rate hikes by central banks worldwide last year. It was the highest since 1974, so many expected that these rate hikes would be enough to bring inflation under control.
The following chart gives a good overview of the global economic situation:
The chart shows the growth of gross national product (GDP), inflation and the unemployment rate in the largest economic nations.
Year-on-year growth is still slightly positive everywhere, but the first quarterly figures are already negative. Compared with inflation, which is very high except in China and Japan, key interest rates are still relatively low. Even if you get more interest for bonds now than a year ago, inflation is almost twice as high as interest rates in almost all countries. In technical jargon, this is referred to as negative real interest rates.
The chart shows the dates of the next twelve Federal Reserve meetings and the probability of an interest rate hike.
The current range of key interest rates is 4.5% to 5%. For the Fed meeting on March 22, 69.4% expect a rate hike of 0.25% and 30.6% an increase of 0.5%. The expectations with the highest probability are highlighted in blue.
The majority of investors thus expect three more key rate hikes of 0.25% in the U.S.A. and then a longer phase of consistently high key rates until they are expected to fall again in a year's time.
Expectations have changed massively in the last 4 weeks. At that time, a maximum rate of 5% was still expected, and interest rates were already expected to fall in the fall.
Everyone hopes that inflation will soon disappear or at least fall sharply. One of the important components of inflation is the service sector. It mainly includes the rising wages.
It has been shown that the price of copper is a good leading indicator of the service sector of inflation. Copper is needed in a large number of production processes and is therefore a relatively reliable indicator of how strongly the economy is growing.
Here, it is to be expected that inflation from the service sector will continue to rise in the next 1-2 months.
Equities still too hesitant to react
Bonds have already reacted to the changing expectations in recent weeks. But not equity prices, which have remained relatively stable.
The chart shows how strongly the companies' profits deviate from the long-term trend. They are still far above the long-term trend. This is illogical if one assumes that key interest rates will rise even further and that a recession may therefore come.
Most investors then also expect the companies' profits to fall. The chart shows the decline in profits that investors expect in the respective industry in the USA in the first quarter of 2023. On average, profits are expected to fall by 5.7%.
In the past, in almost every (except one) recession since 1950, profits have fallen by at least 10%. The major investment bank Morgan Stanley even expects a slump of 15%.
In the coming weeks, we therefore expect that equity analysts will also revise their forecasts for the first quarter and especially for the second quarter of 2023 downwards.
In a Bank of America survey of large institutional investors, they were asked if they plan to increase the equity allocation in their portfolios in the coming weeks.
Only just one-third plan to do so. That's a very low number, but understandable given the current uncertainties in economic trends.
We have also further reduced risk in the past week and are focusing even more on good quality value stocks such as Nestlé or Coca-Cola.
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