Labor Market

The latest CPI and PPI releases, the modestly less hawkish turn in Fed officials’ comments and evidence that consumers continue to spend with some relish support our constructive near-term views on equities and the economy.

The kinked supply framework helps explain why US inflation rose so suddenly shortly after the pandemic began and why the economy is likely to experience a benign disinflation over the next six months.

Central banker messaging after the latest rate hike announcements in the US, UK and Australia indicates a shift in focus from the pace of hikes to how high rates must rise to slow growth and bring down inflation. This represents the next stage of the global tightening cycle, where rates will go higher in countries where neutral rates are higher, like the US, compared to countries with lower neutral rates like the UK and Australia.

This week we present our Portfolio Allocation Summary for November 2022.

While there is much variability in company profitability, earnings contractions have commenced and appear to be broad-based. We expect earnings growth to deteriorate further into year-end. Companies are reporting concerns about the trajectory of future economic growth and the uncertainty that it brings. Consumer spending on goods has slowed sharply, while spending on discretionary services has surprised on the upside. Business-to-business spending is still strong.

As the FOMC explicitly acknowledged this week, monetary policy operates with substantial lags. We see the risks to stocks as tilted to the upside over the next 6 months but are neutral on global equities over a 12-month horizon.

Older workers have deserted the labour force in the US and the UK, but not so in the Euro area and Japan. The result is that wage inflation is red hot in the US and the UK, but not so in the Euro area and Japan. Hence, the Bank of Japan is right to remain a lone dove, the ECB must pivot from its uber-hawkish stance quite soon, but the Fed and the BoE must not pivot from their uber-hawkish stance too soon. We go through the major investment implications.

Falling inflation will allow bond yields to decline in the major economies over the next few quarters. As such, we recommend that investors shift their duration stance from underweight to neutral over a 12 month-and-longer horizon and to overweight over a 6-month horizon. Structurally, however, a depletion of the global savings glut could put upward pressure on yields.

It takes time for wage inflation to die. So, if 2022 was the year that central banks’ monster tightening killed bond and stock market valuations, then 2023 will be the year that it finally reaches the economy and kills profits, jobs, and the wage inflation that has so far refused to die. This means that commodity prices have substantial further downside, while healthcare relative performance has substantial further upside.

Is the US in a wage-price inflation spiral that could lead to more aggressive Fed rate hikes? Is it time to buy UK Gilts after a wild month of volatility? We answer "no" to both questions, as we discuss in this week’s report.