■ Headline inﬂation is at peak (US) or likely to peak in the next few months (Euro area and UK) according to our economists’ forecasts. Given that high and sticky inﬂation has been a headwind for stocks, will peak inﬂation mean markets can ﬁnd a trough?
■ On average, the equity market falls in the run up to inﬂation peaks and rallies in the months after the peak (based on 12 peaks >3% in US headline inﬂation back to 1951). But there is plenty of variation around the average.
■ In 2008, inﬂation peaked but the market fell further as recession ensued; in 2001 inﬂation peaked but equities fell as the tech-bubble continued to deﬂate.
■ In contrast, late 1974, March 1980 and October 1990 are the best examples of a strong post-inﬂation-peak rally. But these periods beneﬁted from a sharp inﬂection in growth around the peak in inﬂation, falling rates and, most crucially, undemanding equity valuations.
■ European and UK equities have typically responded well as inﬂation has peaked. Indeed, European equities typically outperform as US inﬂation peaks. This may be a function of the higher beta of European indices, the UK with a lower beta (and more commodities) tends to underperform after inﬂation peaks.
■ If inﬂation does peak, who stands to beneﬁt? Relationships with inﬂation are not stable over time. In recent months, cyclicals have been negatively correlated with inﬂation as higher prices were seen as damaging for growth so signs that inﬂation has peaked should be good for cyclicals, banks and consumer names.
■ But we’d be cautious of reading too much into headline inﬂation peaking – the uncertainty about the path of inﬂation is high. The downside scenarios for inﬂation often involve lower growth. Also, our economists remain below consensus on economic growth with the consumer being the weakest component.
■ We continue to recommend four areas in Europe – Strong balance sheets (GSSTSBAL), High & Stable margins (GSSTMARG) and companies with exposure to a structural rise in Capex and/or government investment (GSSTCAPX and GSSTFISC). We remain cautious on Consumer areas of the market and while falling inﬂation will be helpful, we remain of the view that discretionary spend will take a sharp dip.
Markets have fallen sharply as inﬂation has risen and as growth expectations have fallen. But our economists think US inﬂation has probably already peaked and expect European inﬂation to peak in the next 2-3 months (Exhibit 1). Even in the UK, where the inﬂation spike has been especially sharp, we think core inﬂation has peaked in April and headline will do so in October once the Energy price cap rises.
The impact of the rate tightening cycle, growth slowing and the falling out of the yoy numbers of some sharp rises from 2021 (autos prices for example) should all help to bring down the pace of inﬂation. In addition, the yoy growth of energy prices is moderating and semis supply is starting to ease. It is also notable that market implied inﬂation has started to moderate too (Exhibit 2).
Of course inﬂation is likely to stay high and we don’t expect it to moderate back to CB’s targets in the near term. Indeed, on our new numbers, Euro area inﬂation stays above ECB target through 2023. Also, the inﬂation expectations of households and corporates have risen and second round effects might prolong the inﬂationary problem, especially with rising wages given tight labour markets. In the UK and US there are more jobs than workers at the moment.
But overall, we think headline inﬂation is likely to be peaking. Could this be a catalyst to support a turn equities? We think it is probably more a necessary than sufﬁcient condition.