What does disinflation really mean for markets?

What does disinflation really mean for markets?
  • Corporate Reporting Season
  • The Fed raises but when will it hold? 
  • Europe on a knife-edge
  • Britain’s downward spiral?
  • Are investors risk-on with crypto?
  • Key events in February

S&P 500   4.64% YTD
Nasdaq 100   12.99% YTD
Dow Jones Industrial Average   2.83% YTD
NYSE Composite  6.17% YTD

Stoxx 600  6.64% YTD
DAX   9.03% YTD
CAC 40   9.32% YTD
FTSE 100   4.15% YTD
IBEX 35  10.56% YTD
FTSE MIB  12.64% YTD

MSCI World Index  7.10% YTD
Hang Seng  11.58% YTD
Bitcoin   42.87% YTD
Ethereum   36.75% YTD

Note: As of 5 pm EST 1 February 2023

Corporate reporting season: hit or miss? According to Refinitiv IBES data, the 22Q4 Y/Y blended earnings growth estimate is -2.4%. Of the 190 companies in the S&P 500 that have reported earnings to date for 22Q4, 69.5% reported above analyst expectations. This compares to a long-term average of 66%. The 22Q4 Y/Y blended revenue growth estimate is 4.5%. Energy stocks have largely outperformed with reported earnings in the sector up over 60% in Q4 2022 while industrials are up almost 40%. 

However, there are some surprises as the more defensive sectors such as healthcare are having problems. Although Novo Nordisk, which reported on 31 January, forecast "strong" sales expectations for 2023 and announced heavy investments into its production capacity, it warned of supply constraints on its best-selling drug. Novartis also disappointed as it forecast that core operating income would only grow in a "mid single digit" percentage range in 2023. It reported its full-year core operating income in 2022 as being broadly flat at $16.7 billion as group sales in 2022 advanced by just 4% to $50.5 billion cheaper generic versions of its MS drug took market share.

Meta Platforms, which owns Facebook, Instagram and WhatsApp, reported fourth-quarter revenues of $32.2bn on Wednesday, a 4% decline from 2021. However, shares rose 18.3% in after hours trading on Wednesday as CEO Mark Zuckerberg called 2023 the "Year of Efficiency." It cut its cost outlook for 2023 by $5 billion, announced an additional $40bn for share buybacks, and forecast first-quarter revenue between $26 billion and $28.5 billion. Net income for Q4 fell to $4.65 billion, or $1.76 per share, compared with $10.29 billion, or $3.67 per share, a year earlier, and below analyst expectations. The decline was largely due to restructuring costs related to office closures, job cuts, and data centre closures. Nevertheless, the positive outlook helped shares of tech peers such as Apple rise 3.3%. 

All eyes will be on the other tech mega caps Apple, Amazon, and Alphabet today as they deliver their Q4 reports. According to Refinitiv, Apple is expected to report its first decline in quarterly revenue in nearly four years after strict COVID-19 curbs in China and related protests suspended iPhone production at its biggest supplier Foxconn. For Alphabet, the world’s largest digital advertising platform, the issue will be whether advertising revenues held firm.

Companies reporting on 2 February: AppleAmazonAlphabetBristol-Myers-SquibbEli LillyRoche HoldingMerck & Co.QUALCOMMStarbucksFord Motor CompanyEstee Lauder CompaniesBall CorporationConocoPhillipsHoneywell InternationalSonyGilead SciencesBecton, Dickinson & Co.Stanley Black & DeckerCognizantDeutsche BankIllinois Tool Works

The Fed’s keeping its eye on its target range. To no one’s surprise the Fed raised interest rates 25 basis points on Wednesday, bringing the federal funds rate to between 4.5 per cent and 4.75 per cent, the highest level since September 2007. During the press conference following the announcement, Fed Chair Jerome Powell said “a couple more rate hikes would be needed to get policy restrictive enough” to bring inflation under control and that he believed positive growth would continue at a subdued pace. He said that although inflation was softening, the labour market remained strong and he did not see recession in 2023. Reactions appeared mixed as investors seem to consider the early stages of disinflation as a signal that the Fed would slow sooner or even reverse policy later this year despite Powell saying “I just don’t see us cutting rates this year” if the economy evolves as he and other Fed policymakers are expecting. What was clear from the Fed’s statement is that it does not want to be accused of being negligent and of doing too little to rein in inflation rather than squeezing the economy too much.

There are further signs of a tighter labour market, as job openings increased 572,000 to 11 million in December, meaning there were 1.9 job openings for every unemployed person, and private payrolls increased by 106,000 in January. This data would usually worry the Fed and markets. Yet, as noted by Chair Powell in his remarks, there are no signs of a wage price spiral yet. Meanwhile the slowdown in the economy is becoming more entrenched as manufacturing continues to slow with the ISM Manufacturing PMI dropping to 47.4 in January from 48.4 in December. It represents the third straight monthly contraction. 

The US hit its debt ceiling, the federal government’s legal borrowing limit, of $31.4 trillion on 19 January. Although the Treasury is taking “extraordinary cash management measures” so that the debt limit is not causing a government shutdown, these measures may only be sufficient through early June. President Joe Biden and Republican House Speaker Kevin McCarthy held initial talks on 1 February about raising US government borrowing limits. They remain divided about how to avoid a default, with both sides agreeing to continue discussions. The White House said “the president welcomes a separate discussion with congressional leaders about how to reduce the deficit and control the national debt.” House Republicans have refused to raise the debt ceiling unless the Democrats agree to significant budget cuts to reduce the national deficit. The Republican legislators have not yet specified what programmes they want cut in exchange for their support to raise the debt ceiling.

The expected slowdown in rate rises is being seen in currency markets with the USD down approximately 2.68% YTD against the EUR, 2.32% against the GBP, and 1.65% against the YEN.

The Energy sector remained strong in January with Baker Hughes CompanyExxonMobil,  Occidental Petroleum CorporationCoterra EnergyValero Energy Corporation and Marathon Petroleum Corporation all ending the month up.

Healthcare stocks have had a mixed month with stocks such Novo NordiskPfizer Inc.Moderna Inc.Merck & Co. Inc.AbbvieJohnson & Johnson were all down while Abbott LaboratoriesUniversal Health ServicesBiogen Inc., were all up. 

Industrials also had a mixed January with CaterpillarGenerac HoldingsW.W. GraingerGeneral Electric CompanyIngersoll-RandBoeing and Illinois Tool Works all up, while Honeywell InternationalLockheed Martin, and General Dynamics were down. 

Europe’s scraping by. As expected the ECB raised rates by another 50 basis points to 2.50% during today’s meeting and suggested another 50 bps rise in March. "... the Governing Council intends to raise interest rates by another 50 basis points at its next monetary policy meeting in March and it will then evaluate the subsequent path of its monetary policy," the ECB said. During the press conference ECB President Christine Lagarde stressed that the ECB will be watching energy prices which feed into inflation and wages. She insisted that the ECB was not done as they still have ground to cover. Data released on 1 February showed headline inflation did moderate to 8.5% in January, from 9% in December, while core inflation was up to 7% from 6.9%. The growth in core inflation will likely keep pressure on the ECB to continue to raise rates. Signs of the ECB’s future aggressiveness will be closely watched as the Eurozone stands at the brink of recession, with growth in Q4 barely squeaking by at 0.1% as the region’s economic powerhouse, Germany, saw a contraction in Q4. 

The UK’s lonely path. The Bank of England, in a 7-2 vote, raised rates again during its meeting today by 50 basis points, bringing the rate to 4%, the highest since 2008. The BoE also changed its inflation forecasts with the MPC’s updated projections showing CPI inflation falling back sharply from its current very elevated level, of 10.5% in December, to fall to around 4% towards the end of this year,  In a speech following the release of the decision, BoE Governor Andrew Bailey said, "Since the November monetary policy report we've seen the first signs that inflation has turned the corner, but it's too soon to declare victory just yet, inflationary pressures are still there.” He said further interest rate hikes would depend on evidence of more persistent price pressures appearing. For many in the market, this suggested that rates may peak at 4%. The IMF has forecasted the UK to be the only advanced economy that experiences a contraction in 2023; it has forecast -0.6% growth for the UK. Wages are continuing to rise, putting additional pressure on the BoE to contain inflation expectations. In addition, a series of strikes by public sector workers such as train drivers, nurses, postal workers and teachers has added to the overall negative outlook.

Is crypto back in fashion? The leading cryptocurrency, Bitcoin, has had its best January since 2013. According to Coingecko.com, smaller coins like Solana, Axie Infinity and Decentraland have doubled in value, part of an approximately $280 billion January jump in digital assets. As noted by Bloomberg, the rise in risk appetite appears to be correlated with the Fed’s expected continued slowing of interest-rate hikes with some investors expecting the Fed to even cut borrowing costs later this year as inflation moderates further. It may also be due to greater clarity related to the bankruptcy proceedings and corporate restructurings of some of the big exchanges like FTX and of cryptocurrency hedge funds like Three Arrows Capital. Or it could be due to greater transparency about just how much some of the now defunct exchanges like Genesis Global owe; Genesis’s Chapter 11 filing listed seven creditors owed at least $100 million with it owing its top 50 creditors $3.4 billion. Filings by FTX have it owing $3.1 billion. However there seems to be some movement on possible payment. On 1 February for example, a court filing by the bankrupt crypto lender Celsius said some users will be able to withdraw 94% of their eligible assets. Regardless of what the expected correlations may be, there is the risk that the soft economic landing markets are hoping for doesn’t happen, that rates not only stay higher for longer, they do not get cut in 2023.

Key events in February 

2 February 2023 Bank of England Monetary Policy meeting and minutes. The BoE is highly expected to continue with further tightening to bring inflation under control although the slowdown in growth may temper the rate of hikes in subsequent meetings. As of Wednesday, 1 February, investors were pricing in an approximate two-in-three chance that BoE rates will peak at 4.5% by June.

2 February 2023 European Central Bank Monetary Policy meeting. Both the head of the ECB, Christine Lagarde, and other policymakers have been very clear that the ECB will raise rates 50 basis points during this meeting and most probably in March. The question for investors will be about future movements in Q2 and beyond and whether the ECB will, like the Fed, at least consider smaller rises in line with what the US Federal Reserve is doing as the outlook for the Eurozone points to slowing growth if not recession in some countries.

09 - 10 February 2023 European Council Meeting. The European Council of EU leaders will meet to discuss migration and competitiveness between the US and China.

23 - 25 February 2023 G20 Finance Ministers and Central Bank Governors Meeting. Finance Ministers and Central Bank Governors of G20 members will meet in Bengaluru (India) to discuss global financial issues, including energy prices and inflation rates.

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