Not raising our sails althougt the wind of inflation is picking up

There is a strong focus on price inflation, and core inflation in the US has risen in a short time from an annual growth of about 1.5 per cent to almost 4 per cent. The fear is that this trend is more persistent than the central bank and large parts of the market expect. Subsequent interest rate hikes to control inflation will be a likely scenario if price inflation remains at a high level. This will have a negative impact on the stock market. There are more than enough factors to indicate a challenging stock market, including high valuations, soaring commodity and energy prices, bottlenecks in manufacturing and distribution chains, and a China that may not be stepping quite as hard on the growth pedal as before.
On the other hand, companies are showing resilience and are delivering consistently good figures. Just over half of the companies on the broad index S&P 500 have delivered surprisingly positive third-quarter figures, especially on the bottom line. Economic growth is admittedly not as good as it was immediately after the reopening, but then again, that was not to be expected. Stagflation is a phenomenon that has been mentioned in debates about the current economic situation. In our view, we’re not quite there yet. If we were, we would have to see a significant reduction in growth, pushing it below trend. We are therefore maintaining a neutral weighting in equities and are making no changes in terms of sector or region. We are also maintaining an underweight position in global interest rates. 

The wind of inflation 
As mentioned, there is a lot of discussion concerning inflation predictions. The reason for this is the sharp rise in prices that came in the wake of the pandemic. The big question is whether this is temporary and thus just noise in the data series, or whether we’re now entering a period of higher inflation. It’s too early to give a clear answer. There are good arguments for both scenarios. If we take a closer look at price inflation in the US, it is particularly the price of goods that is rising. This is because goods consumption exploded during the pandemic, since many services were simply not available. At the same time as demand for goods rose, challenges presented themselves on the supply side. For example, there are still capacity problems in many important ports. This means that containers are staying put for much longer than normal, which obviously causes delays in the flow of goods across continents. The economy’s stuck in the wrong gear. And the result is higher prices. There is reason to believe that these disruptions are temporary and will normalise as the effects of the pandemic subside. 
If the increased price inflation is to take hold, we must also see traces of it in wage growth. If we look at the latest wage growth figures, they haven’t increased substantially. However, a number of companies report that it has become more difficult to retain employees and to attract new ones. Surveys also indicate that the supply of labour has decreased since the pandemic. Older workers have chosen to retire, while others have chosen to stay at home. It’ll thus be important to follow the wage and price inflation figures, as we may find ourselves in a period of change. Not least, it will be important to keep an eye on how central banks are assessing the situation. 

Uneven growth picture 
Growth in the leading economies has been fragmented in recent quarters. There’s no doubt that it’s passed its peak and has fallen in almost all regions. The question is whether growth will be strong enough for the companies’ earnings to be satisfactory. If we look at the confidence indicators, which are based on feedback from business managers, the picture is positive. This applies in particular to the US. For the service industry, the indicators mostly point upwards, while for the manufacturing industry they are somewhat down, albeit from high values. The great element of uncertainty is China. Close-to-zero tolerance of new outbreaks of infection, combined with, among other things, closed ports, can further exacerbate the problems we’ve seen in the distribution channels. Furthermore, there is little to indicate that there’ll be much in the way of stimulus packages from the authorities. In addition, there’s uncertainty as to how China will approach the problems in the real estate sector. The challenges in the country are the reason why we downgraded emerging markets down to underweight last month. 

Stagflation not very likely 
The stagflation scenario has been raised in connection with rising inflation and somewhat slower economic growth. Many point to similarities with the 1970s, which was the last time we saw a situation of sharply rising inflation combined with a fall in GDP growth and rising unemployment. This is an unfavourable climate for the stock market, and the 1970s were also a weak period. It can certainly be argued that there are some similarities: long-term inflation expectations have increased, monetary and fiscal policies are clearly expansionary and there is a risk that there will still be a lack of various types of components and price-driving bottlenecks on the production side. 
However, there are also significant differences. 
  • Low interest rates and low unemployment over time had put pressure on the economy in the late 1960s. This legacy was a bad starting point for the economy in the 1970s. The situation we experienced in the period before the pandemic was not comparable. 
  • Global trade is on a completely different level than it was in the 1970s. The scope of global trade today helps keep prices down. 
  • Today, the world is not as vulnerable to energy price shocks like the ones that occurred at several junctures in the 1970s. 
We are therefore not preparing for a repeat of the 1970s. 

The reporting season 
The reporting season for the third quarter is well underway. More than half of companies have published their results. Even though future earnings are the basis for equity prices, it’s important to keep an eye on the real earnings figures, as they can give an indication of what to expect in the time ahead. The third quarter figures so far look good. In particular, it’s the bottom line results that are surprisingly positive. In other words, companies have managed to improve their margins, and their results have helped raise equity prices in October.