Source: Golden Ten Data
Author: Dongdongdong
Goldman Sachs predicts that while food and energy prices are likely to continue surging in the coming months, core prices may have peaked and will trend lower next year.
At the same time, Goldman Sachs believes that tightening policies in the United States will have a major impact on the labor market, which will crush the American consumer, whose savings rate has just hit a 14-year low and credit card debt is rising vertically.
Goldman Sachs economists wrote in a report over the weekend that U.S. inflation may have peaked and expects European inflation to peak in the next 2-3 months. Even in Britain, where inflation has soared particularly sharply, Goldman sees its core inflation peaking in April and headline inflation peaking as the energy price ceiling rises in October.
To be sure, the impact of the rate hike cycle, slowing growth, and a pullback in the year-on-year growth of some of the prices that have surged since 2021, such as auto prices, should help slow the pace of inflation.
In addition, year-on-year growth in energy prices is slowing and supply chain woes have eased. It is also worth noting that the market’s implied inflation expectations are also starting to move lower.
All in all, Goldman believes headline inflation may be peaking, which may be a necessary but not sufficient condition to support a stock market turnaround .
Looking back at U.S. history, Goldman Sachs pointed to the peak of headline inflation since 1950 (the bank only selected the peak data of annual inflation above 3%, a total of 12).
In terms of market expectations after inflation peaks, Goldman Sachs shows in its next chart that, as seen in recent months, markets typically fall when headline inflation peaks . While inflation was more volatile after peaking, it did recover on average.
Of course, there are times when there are surprises. Goldman acknowledged that the stock market could benefit from peaking inflation , but it does need other support , especially if investors worry about a further economic downturn. Below are three factors that Goldman Sachs listed as influencing stock market movements.
economy:
Inflation peaks are often followed by a persistently weak economic outlook, with ISM data continuing to fall, as was the case in the 50s / 60s and mid-80s .
But there are some exceptions. After inflation peaked in late 1974, markets recovered sharply and the economy turned around, with ISM data up 24 percent in the 12 months since December 1974. In the early 1990s, ISM data also showed strong growth after inflation peaked.
Goldman noted that December 1974, March 1980 and October 1990 were good times to buy stocks when inflation peaked, as the economy was at or near a trough. On three occasions when inflation peaked , buying stocks turned out to be negative , in December 1969, January 2001 , and July 2008, two of which were because the economy was in or about to enter the Recession (1969 and 2008).
Goldman Sachs cautioned that while a recession is likely after the recent peak in inflation , the focus will be on what remedial measures the Fed will take .
Valuation:
In January 2001, the market continued to fall after inflation peaked, and valuations were still starting at a high level. And the stock market was a good buy point after inflation peaked in September 2011, not because the economy was about to get better, but because valuations were low . At the end of 2011, the S&P 500 was trading at 11 times forward earnings.
interest rate:
Another support for the market after inflation peaked was lower interest rates. Both long-term and short-term interest rates generally fall, but the declines are more pronounced on the shorter end of the curve. On average, 2-year U.S. Treasury yields fell by 90-130 basis points in the 12 months after inflation peaked.
The situation in European equities before and after inflation peaked is similar to that in the US: European equities were weak in the months before inflation peaked, but rose on average after inflation peaked. In fact, European stocks typically outperform when U.S. inflation peaks. This may be due to the higher betas of European equities, while the UK, which has a lower beta, tends not to outperform after inflation peaks. The U.K. stock index is dominated by commodity-linked stocks, perhaps explaining its relative resilience during peak inflation.
To be sure, inflation performance is often associated with lower equity valuations during periods of high inflation, which is why Goldman warns that even if inflation falls from its peak, assuming it remains sticky and high and higher than in the previous cycle, then Valuations are likely not to rise to levels seen in the last cycle with low and less volatile inflation.
It is not only the level of inflation that deserves attention , but also the volatility of inflation. When inflation is more volatile (a sharp rise in inflation followed by a sharp fall as growth slows), it can be even worse for the stock market. Uncertainty over monetary policy and margin calls has made it generally difficult for stocks to digest high inflation volatility. Tighter energy and labor markets not only push up inflation, but also increase volatility (as seen, for example, in natural gas prices).
So if inflation peaks, which asset class will yield the most?
Goldman notes that the stock market’s relationship with inflation is not stable over time: Over the past decade, higher inflation has boosted cyclical and value stocks, while low inflation has dampened their performance. But now the relationship has reversed, and higher inflation has hurt cyclical and value stocks (excluding commodities). This is because inflation is increasingly seen as supply-side rather than demand-driven, and ultimately limits the pace of growth.
Therefore, inflation will force the Fed not to ease monetary policy even when growth is slowing. In this sense, peaking inflation should be good for cyclical stocks. Banks and consumer discretionary stocks are also now significantly negatively correlated with inflation.
How stocks perform in relation to inflation will largely depend on whether peak inflation is seen as a sign of the end of an aggressive rate-hike cycle and ultimately gives the Fed room to ease policy if necessary. Uncertainty around the potential path of inflation and the likelihood that inflation will remain sticky and high will dampen the momentum for a sharp rally in equities. As Goldman Sachs shows below, the bank’s economists modeled various inflation scenarios, with inflation remaining high in most cases. Therefore, Goldman Sachs firmly believes that in the near future, inflation will be replaced by deflation.
Goldman also noted that another consideration is that higher inflation now may still be “ discounted . “ Consumer discretionary remains vulnerable even as inflation slows, the bank warned. While equity valuations have fallen, demand is likely to be hit by persistently high inflation and its impact on real wage growth .
So far, Goldman believes that the hit to the consumer sector, which it has been focusing on, remains relatively modest, but as Goldman shows in the table below, what awaits the U.S. economy may be continued high inflation growth and a consequent surge in real wages Negative growth. While the U.S. economy is changing rapidly: a historic plunge in new home sales, a record surge in credit card debt and a drop in savings.
With this in mind, Goldman recommends investing in the following four categories of European stocks: strong balance sheets, high and stable profits, and rising capital spending and government investment spending. The bank is cautious on stocks in the consumer sector, and while lower inflation is a plus, it sees a ” sharp decline in discretionary spending ” that will hit consumer stocks.
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