Real Wealth Concepts

Inflation, Earnings & Value: Macro Soundbites for the Week Ending March 3, 2023

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This week’s macro soundbites covering inflation, earnings and value vs growth.

Featuring insights from Mohamed El-Erian, David Rosenberg, Wei Li, Avery Shenfeld, David Kelly and more.

Answering the following:

  • Will inflation and policy rates remain higher for longer?
  • Will Bank of Canada policy diverge from Fed policy?
  • What is the near term and long term earnings potential for US companies?
  • What could trigger a sharp rally in risk assets?
  • Will value beat growth?
  • How is inflation changing consumer behavior?

(Full article below.)

February returns

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Source: Mohamed El-Erian

Will inflation and policy rates remain higher for longer?

Mohamed El-Erian, President at Queens’ College, Cambridge:

“There is now growing recognition that there is a limit to goods disinflation and that price increases in the services sector may prove quite stubborn. This better understanding of short-term inflation dynamics is a necessary step to avoid the Fed falling far behind for the third time in two years — a pattern that fuels the combined threat of persistently high and destabilising inflation, recession, job losses and widening inequality of income and opportunity.”

“In my opinion, the fundamental medium-term characterisation of the US economy has shifted from one of deficient aggregate demand to one of deficient aggregate supply. Yes, the pandemic contributed to this but there is a lot more going on.” (Source)

Sagar Singh Setia, Marquee Finance:

“The spread between the ISM New Orders and Inventories is still in the recessionary territory.

However, the biggest surprise was the ISM Prices Paid which recovered sharply to 51.3, indicating that the pricing pressures remain firm (I essentially believe it’s due to the commodities rally that ensued post the Chinese reopening).

Today’s data release further confirms that rates will be kept higher for longer as the contraction in cyclical activity is having little effect on sticky inflation. (though I still believe the base effect will put some downward pressure in the coming months- H1)

The Fed Funds Futures reacted to the data pretty quickly and the peak rate is now estimated at 5.5%, and thus the odds of a recession keep on increasing.” (Source)

David Rosenberg, President, Rosenberg Research & Associates:

“This Fed continues to believe it has to fight for its perceived loss of credibility this cycle. It has two fears. One is the memory of Arthur Burns in the 1970s and even Paul Volcker in 1980, which is ending the tightening cycle prematurely. Second, the Fed is consumed with financial conditions, which is a critical input to its macro forecast.” 

Will Bank of Canada policy diverge from Fed policy?

Avery Shenfeld, Chief Economist, CIBC Capital Markets:

“Monetary policy needn’t tighten as far in Canada as what might prove necessary stateside. Household debts and debt service costs are higher in Canada, and more impacted by interest rate changes due to the lack of long-term locked in mortgages. Moreover, neither wages nor prices look quite as hot in Canada.” (Source)

What is the near term and long term earnings potential for US companies?

David Kelly Chief Global Strategist at J.P. Morgan Asset Management:

“…even if the economy avoids recession, 2023 will be a difficult year for corporate profits. If there is a recession, profits will likely fall sharply. However, as the economy stabilizes and settles into what we believe should be a slow-growth, low-inflation and low-to-moderate interest rate environment, profits should recover and likely outpace economic growth overall. 

Since the mid-1980s, adjusted after-tax profits have risen from roughly 5% of GDP to over 10% of GDP. This doesn’t reflect fast economic growth, extraordinary productivity gains or a tailwind from a falling exchange rate boosting overseas earnings. Rather it is testament to the success of corporations in growing their share of the pie by squeezing labor costs and boosting sales. Profits have also received an assist from Washington in the guise of generally falling corporate tax rates and low real interest rates. While these trends have stalled, to some extent, in the current post-pandemic economy, they should re-emerge in the years ahead, providing strong support to U.S. equities.” (Source)

Sadiq S. Adatia, Chief Investment Officer, BMO:

“…overall, the trend has been of declining profits. Some have even called it an earnings recession, which reveals the negativity that’s prevalent across the market right now. We expect to see subpar results for another quarter at least, tied to three key factors. First—inflation has come off, driving price points lower. And though consumers are still spending at a decent rate, they are being a little more selective and have started to reduce quantities as well. Finally, while we’ve seen supply chains improve during the past year, we are not necessarily seeing input costs decline as quickly as that of end products, which creates pressure on profit margins.” (Source)

What could trigger a sharp rally in risk assets?

Jim Caron, Managing Director Global Balanced Risk Control Team, Morgan Stanley:

“It’s hard to time things perfectly, but we see inflation moving lower in the narrative, the terminal policy rate to eventually settle in around the 5.25% area, which is where we’ve been all along. And if there’s a risk of this view, I will admit it is to the upside, it could be as high as 5.50%. Now, why is this important? Because a sharp selloff in assets is based on the narrative of rising inflation in tighter policy. If this proves false, or even if it’s a more balanced narrative that emerges, let alone one in which inflation falls as we think it will, then it could lead to a sharp positive reversal upward for asset prices. That’s just a risk that I think we need to be wary of, especially in light of all the cash that’s still on the sidelines.” (Source)

Will value beat growth?

Wei Li, Global Chief Investment Strategist, BlackRock Investment Institute:

“Growth stocks have led the U.S. equity rally so far this year, halting outperformance in 2022 by value equities. We believe value stocks can resume their climb as major central banks keep interest rates higher for longer. Higher rates reduce the value of future cash flows, weighing more on growth stocks and reinforcing our developed market equities underweight. Underneath that, our sector and region preferences tilt to value with quality attributes and growth at a reasonable price.” (Source)

How is inflation changing consumer behavior?

Anuj Nayar, Financial Health Officer, LendingClub:

“Consumers have accepted that inflation is part of their everyday lives and they are actively making behavior changes, especially during the 2022 holiday shopping season, to adjust their spending and better manage their cash flow.” (Source)