Can equities survive the fight against inflation?
Insights

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.

Sharp tightening in credit to smaller firms in the US

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.

US labour market easing distorted by fraud in the data

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.

Consumer confidence gap vs US narrowing fast

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.

Recent fall in mortgage rates set to reverse

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.

Enormous changes in 10 year US real rates
12 June 2023
Steven Bell
Steven Bell
Chief Economist, EMEA
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Can equities survive the fight against inflation?

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For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and
may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

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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.

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

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Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and
may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香 港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

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.

This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

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

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