The US consumer price index rose 8.6% in the year to March, or 6.5% excluding food and energy. We have to go back to the oil shocks of 1973 and 1979 for anything comparable. Even in 2008, during the subprime crisis and when some commentators were talking of a third oil shock – crude prices were close to $150/bbl at the time, compared with around $105/bbl for WTI at the moment – US inflation got to only 5.5% in mid-year before falling back sharply. Moreover, the core inflation rate never exceeded 3% at the time, i.e. half the level it is now. Inflationary pressure is far greater today and implies a complete change of direction for a Federal Reserve that is already threatening higher interest rates.
The Covid pandemic raised both commodity prices and unit wage costs, the former because of China’s rapid economic recovery (down to the initial success of its zero-Covid strategy) and the latter because of the adaptation of production methods to measures such as home working and social distancing. We would normally have expected inflation to pick up and then firmly establish itself, but initially at least this is not what happened. The reason was an improvement in US labour productivity: in 2020, GDP per hour worked rose by 2.6% year-on-year despite the pandemic. Apart from remaining relatively tame until the spring of 2021, inflation therefore looked pretty transitory, deceiving both commentators and the experts…
The recent inversion of the US yield curve leaves little room for doubt. The markets no longer believe in a temporary blip in inflation but a rapidly worsening situation. Quite rightly, they expect the Fed to tighten its monetary policy significantly, which will probably nudge the economy towards recession. Fed Chair Jerome Powell is clearly on that wavelength, as he announced a 50bp rate hike in May from the 0.5% set in mid-March. Another hike of the same magnitude was also under consideration. Although the Fed has long sought to guide economic agents through commentary and half-measures, there can be no mistaking its mood. It has almost certainly switched track in response to a poorly calibrated fiscal policy.
The Q1 2022 results season is under way, with 55% of the S&P 500 companies already published. As expected, the numbers contrast with the stratospheric profits gains announced in 2021. S&P 500 earnings are now expected up 7.1% for the quarter, which would be the smallest increase since Q4 2020. Even so, there is still momentum behind positive revisions : the FactSet consensus at end-March was just 4.7%, and at 80% the proportion of positive surprises remains very high. It is simply that the magnitude of surprises is much smaller.
Taken as a whole, 2021 saw a 47.7% increase in S&P 500 profits! As the index itself appreciated ‘only’ 26.9%, this severely dented the exorbitant multiples that we saw the year before. The decline in equity prices this year has only amplified this phenomenon. The S&P 500 has corrected 13.3% since the start of the year, reflecting investors’ fears over the risks to US economic activity, surging prices and on top of it all the war in Ukraine and its impact on raw materials. Highly sensitive to interest rates, tech shares have lost even more ground: the Nasdaq is down 21.2% since the start of the year. Multiples have effectively normalised and are back to their pre-crisis levels irrespective of the calculation method (i.e. based on results published over the past 12 months or using consensus forecasts for the future).
