According to Insync Funds Management (Insync) there is further evidence supporting many of the views it held back in its 2022 industry White Paper Will the second half and beyond for equities be different to the first? (White Paper).
In this White Paper, Insync said five common assertions had been stirring the pessimism pot, one of which was that the resumption of rising interest rates, and therefore inflation, is firmly established.
Insync Portfolio Manager John Lobb said, “We disagreed with those pessimistic assertions then, and in the face of further evidence, we still disagree.”
In August 2022, Insync said the incredible rate of money creation during 2020-2021 of 20% to 30% pa, had dramatically slowed to the average of the historic range of 5-6%. Excess money had been chasing an interrupted supply of goods and services up until last year, pushing up prices artificially.
“Today, the Money Supply (M2) rate of change is negative (-1.3%). This has not happened for at least 80 years,” Mr. Lobb said. “This development would be of concern to the Federal Open Market Committee (FOMC), since productive investment relies heavily on the availability of credit.”
In 2022, Insync had also pointed out that inflation of the price of goods leaving the gates of Chinese factories, which had been running at 13-14%, had dropped back to 4%.
“The factory gate prices of Chinese manufacturing plants have now declined at -1.3% over the last year,” Mr. Lobb said.
Additionally, he said that a decline in the net number of small to medium (SME) businesses looking to implement price hikes, also identified by Insync in August 2022, had continued to such an extent that SME pricing intentions in the next three months now match those prior to the pandemic.
Looking to carbon energy supplies, which was also touted as an ongoing inflationary pressure, the reverse has been true.
“It fell even further than we predicted," Mr. Lobb said.
“In more normal times, central banks largely ignore the ebb and flow of global energy and food prices. However, in today’s conditions where the labour force has contracted, rises in food and energy prices may strengthen the case for higher rates since pay demands could create a more sustained impulse to inflation.”
Mr. Lobb said that fortunately, Natural Gas (MMBtu) has dropped 65% in less than six months, back to the same level as that during the previous four northern hemisphere winters.
“Besides being used for heating, it's a core determinant of fertiliser and thus food prices. Crude oil and therefore gasoline prices, have declined in excess of 20% to $78/barrel in the last six months. This is even below its price prior to the Russian invasion of Ukraine,” he said. “So, whilst the FOMC is usually more interested in CPI ex food and energy, they would appreciate how reductions in the prices of these non-discretionary goods has a positive indirect effect on wage demands in what is a tight labour market.”
Insync had asserted that inflation over the past few decades had been abnormally low, and they had expected it to settle around its longer-term norm, which is not bad for equity markets.
“This is exactly what it is heading towards. Five-year inflationary expectations are now congruent with the 5-10 year inflationary expectations (2.3%) which will calm the nerves of the FOMC,” Mr. Lobb said.
“It has always been our view that long term inflation expectations will not revert to those of the recent abnormal past of around 2% due to a less (internationally) mobile labour force and a higher degree of onshoring. Nevertheless, the FOMC’s expectations will also be tempered by their assessment of the new global regime, mainly attributable to the re-evaluation of geopolitical risk by large corporates.”
Insync had also noted that looking at the core drivers of inflation it was hard to see price rises continuing as had been the case in the previous year and, if the prices of the core drivers of inflation stabilise, inflation would drop dramatically in this coming year.
“Even total weekly wages, a significant driver of ‘stickier’ service inflation, are now only growing at 3.5-3.75%, similar to the rate of growth that existed in 2019,” Mr. Lobb said.
“As employees and managers become more accustomed to the increased prevalence of the hybrid work schedule, productivity should recover from the currently negative -1.7%, leading to an even greater improvement in unit labour costs (ULC). The Federal Reserve is keenly aware that ULC is the real culprit of endemic inflation.”
While Insync believes the global economy is unlikely to regain its ‘fluidity’, it also believes the central banks will feel more comfortable promoting a more neutral policy stance based on the above developments.
“Perhaps for those investors that hold a pessimistic view, it may be time to question this, to deploy assets towards those equites that are primed to deliver above average earnings growth in a mediocre at best, GDP environment,” Mr. Lobb said.