Can equities survive the fight against inflation?

Can equities survive the fight against inflation?

Surprising developments change the story, but likely not the ending.

News and developments have pointed to interest rates being higher for longer. However, while this has not been helpful for government bonds, our favoured asset class, we don’t see this changing our fundamental outlook and we continue to be neutral on equities, preferring to be cautious and selective.

The risk of a credit crunch in the US has been averted by the Fed’s swift action on the banking crisis. That pushes back our expectation of a US recession and so makes it less certain. However, the revelation of fraud boosting unemployment claims means that the US labour market has actually remained tight, so wages will be back to being the Fed’s main concern. That means the credit squeeze in the US continues, reflecting tightening monetary policy. So, while the news on falling inflation had been positive, the expectation of rate cuts needs to be postponed until wage inflation falls back, still mostly likely as a consequence of a recession.

Elsewhere, UK inflation has provided stickier than expected, but still should be three-point-something by the end of the year, while the German consumer seems to be missing, but is probably just enjoying an extended holiday in Spain. We have updated our charts, but not changed our recommendations.

US

As predicted, the collapse of SVB and mini-crisis in mid-sized US banks caused a sharp downtick in credit availability. But surprisingly, the following survey revealed that this was just a blip. That means that the Fed’s swift action has averted a credit crunch. However, that still leaves a continuing credit squeeze, reflecting tightening monetary policy. Overall, that pushes back our expectation of a US recession and so makes it less certain.

Another piece of data that turns out to have been a blip is the pace of rising unemployment claims in the US. The majority were down to a single state, Massachusetts, where fraud has been revealed. That means that the US labour market remains tight, with wages being the Fed’s main concern.

This is particularly disappointing as our forecast model and the monthly data indicated that the key rental component of US inflation has come off the boil. If the jobs market had been easing at the same time as inflation came down, that could have made for a smoother adjustment to more sustainable wage expectations. While the much-forecast US recession is now further away, we can’t see the Fed doing anything but keeping monetary policy conditions tight until wages ease.

Europe

Some key indicators for the crucial German economy have got worse even as we have become more enthusiastic over the outlook for the Euro-zone economy. However, we see the poor German manufacturing orders as reflecting the current global de-stocking cycle as well as a shift away from investment in energy-intensive industries. Similarly weak German retail sales could reflect a shift to services and experiences over goods, or that German consumers are extending their holidays in places like Spain, where retail volumes are up as much as 10%.

We remain confident that the significant decline of not just current energy prices, but also prices for the next winter, since their peak last year, will translate into lower inflation with increased consumer confidence and spending driving a virtuous circle through the rest of the economy. That European consumers have actually increased savings during the recent squeeze indicates the scope for the recovery.

The ECB will have to continue to increase interest rates. Wages are rising and that is set to accelerate this year as backward-looking indexation kicks in.

UK

Another set of disappointing UK inflation figures has made the Bank of England’s job easier. Another rate rise is now expected for next month, with likely another one to follow. However, the energy price fall and the reversal of sterling weakness means that inflation will fall both at the headline and underlying level. We still expect inflation to be three-point-something by the end of the year.

Lower inflation and an unspent ‘Covid piggy-bank’ mean that the UK consumer will support the economy, just as we see in continental Europe. A recovering economy has also pulled people back into the workforce, supporting growth.

However, each economy is different, and the housing market is a key characteristic for the UK economy. Here higher interest rates are going to continue to overhang mortgage holders, with significant hikes coming through as fixed-term rates come to an end. That headwind will have a bigger drag on UK consumer confidence than in the euro-zone.

We remain confident that the significant decline of not just current energy prices, but also prices for the next winter, since their peak last year, will translate into lower inflation with increased consumer confidence and spending driving a virtuous circle through the rest of the economy. That European consumers have actually increased savings during the recent squeeze indicates the scope for the recovery.

The ECB will have to continue to increase interest rates. Wages are rising and that is set to accelerate this year as backward-looking indexation kicks in.

US equities to underperform, dollar to weaken, bonds to rally

The move from quantitative easing (QE) to quantitative tightening (QT) has had a big impact. We can see that reflected in the risk-free rate, with US 10-year TIPS (Treasury inflation-protected securities) now yielding over 1.4% as opposed to a substantial negative real yield during QE. While recent news on inflation and interest rates have gone the wrong way, we see good value in government bonds at these levels.

While we are overall neutral on equities, we are negative on US equities. That’s not worked at an index level, but it’s been a very narrow rally, with gains on just five stocks accounting for more than all the rally in the S&P 500 so far this year. Company profit margins are being squeezed in the US and there is also the likelihood of a recession. By contrast margins are widening in Europe and we see scope for positive economic surprises as Europe enjoys a virtuous circle of lower inflation and stronger demand.

US interest rates may end 2023 below those in Europe. That will be a dramatic change, the first time that this has happened in the euro’s history, leading to a weak US dollar.

Steven Bell
Chief Economist, EMEA
Share on linkedin
Share on email

You might be interested in...

1 July 2024

A tough fiscal reality awaits new government

An incoming government will have to raise taxes. Politically, this is best done quickly – will courage prevail?
Watch time - 8 min
17 June 2024

Back to basics: why the time is right for a return to multi-asset

The great reset in bond yields and the prospect of inflation falling further means multi-asset is once again an attractive option for investors seeking a smoother return profile.
Watch time - 6 min
17 June 2024

Elections, interest rates and markets

A record year for elections – but what do they mean for markets?
Watch time - 6 min

Why Columbia Threadneedle for low-cost multi-asset

Columbia Threadneedle Universal MAP redefines value through active multi-asset solutions and business support at a passive price point. Fund OCFs at 0.29%-0.39%.

Our Portfolio

The Columbia Threadneedle Universal MAP and Sustainable MAP ranges offer risk-controlled portfolio options designed to cover a host of client growth, income and sustainability needs.

Important information

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

For professional investors only.

This financial promotion is issued for marketing and information purposes only by Columbia Threadneedle Investments in the UK.

The Fund is a sub fund of Columbia Threadneedle (UK) ICVC III, an open ended investment company (OEIC), registered in the UK and authorised by the Financial Conduct Authority (FCA).

English language copies of the Fund’s Prospectus, summarised investor rights, English language copies of the key investor information document (KIID) can be obtained from Columbia Threadneedle Investments, Cannon Place, 78 Cannon Street, London, EC4N 6AG, email: [email protected] or electronically at www.columbiathreadneedle.com. Please read the Prospectus before taking any investment decision.

The information provided in the marketing material does not constitute, and should not be construed as, investment advice or a recommendation to buy, sell or otherwise transact in the Funds. The manager has the right to terminate the arrangements made for marketing.

Financial promotions are issued for marketing and information purposes; in the United Kingdom by Columbia Threadneedle Management Limited, which is authorised and regulated by the Financial Conduct Authority; in the EEA by Columbia Threadneedle Netherlands B.V., which is regulated by the Dutch Authority for the Financial Markets (AFM); in Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland. In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Thank you. You can now visit your preference centre to choose which insights you would like to receive by email.

To view and control which insights you receive from us by email, please visit your preference centre.

Play Video

CT Property Trust- Fund Manager Update

Sed ut perspiciatis unde omnis iste natus error sit voluptatem accusantium doloremque laudantium