No Shelter From Inflation


Following a burst of activity at the start of the year, markets calmed down last week. Bonds were little changed following the sharp rise in yields seen the previous week. As for equities, they fell slightly further with global markets now down a bit over 2% from their high on 4 January.

Beneath the surface, the rotation out of growth stocks into cheaper value stocks continued, with UK equities a major beneficiary and US equities the main loser. The UK outperformed the US by a further 1.4% last week.

We believe this move has further to run over coming months. The UK still looks excessively cheap, with a price/earnings ratio some 30% lower than the rest of the world, and the US excessively expensive with a valuation premium as high as 50%.

The UK’s recent burst of outperformance has also been assisted by a strengthening of the pound. Against the dollar, it is back up to $1.37 from a November low of $1.32. A rather weaker US currency has helped but it also reflects independent sterling strength.

The latter is a bit surprising with all the turmoil at Downing Street, unless of course the markets view a potential early exit by Boris as a positive. That said, the pound will be garnering support from the December rate rise and the expectation, with inflation likely to peak at 6% or higher in April, of a further increase in rates in February.

UK GDP posted an unexpectedly strong 0.9% gain in November, which left activity above its pre-pandemic level for the first time. While December and January will very likely see this increase unwind, February should see renewed growth with the government apparently set to let covid restrictions lapse at the end of the month.

Outside the UK, the US inflation data were the big news. As expected, the headline rate rose in December to a 40-year high of 7.0%, while the core measure increased to a 30-year high of 5.5%. Inflation should now be very close to a peak but the pace and extent of the decline from here remains a subject of intense debate.

One complicating factor is the cost of shelter (which accounts for over 30% of the consumer price index in the US) with rental inflation now picking up considerably on the back of the surge in US house prices. This is boosting inflation, just as some of the factors behind the initial surge (such as energy and used car prices) are set to go into reverse.

All the same, Fed Chair Powell did his best last Tuesday to reassure Congress. He said the Fed was determined to ensure higher inflation did not become entrenched and that the economy was well placed to withstand a tightening of policy.

While inflation is the main focus for markets at the moment, the news on growth is not unimportant and today saw the release of Chinese growth numbers. These proved a mixed bag. GDP posted a stronger gain than expected in the fourth quarter but growth slowed to 4.0% versus a year ago and retail sales were unexpectedly weak in December.

The Chinese authorities have recently started to ease policy a little to prop up growth. Omicron, however, is posing an increasing threat with more widespread and damaging lockdowns now being required to maintain the zero covid policy. This contrasts with the West where the damage to growth from Omicron should be limited with activity recovering later this quarter as restrictions are eased.

Finally, JPMorgan kicked off on Friday the US fourth quarter reporting season. The results were strong and better than expected but talk of increased cost pressures going forward took the shine off them. Reporting continues this week and will be closely watched by investors, particularly with earnings set to be the primary driver of any further gains in equity markets.

Related: Time To Value