Stagflation? No, Boom-Inflation

27 March 2022 _ News

Stagflation? No, Boom-Inflation

In recent months we often hear talk about Stagflation, but let's not lose our bearings and look at the numbers for the US  economy. Before going into the numbers, let's summarize and contextualize the US situation.

In the US, we have experienced two years of pandemic in where  the average American, a serial consumer, has been confined   to his home and his wealth has increased thanks to tax aids, which have more than offset  the impact of the pandemic.  Since there is no shortage of work in America, with unemployment below 4%, consumer spending will  remain very high also to compensate  for the lack of consumption during the pandemic years, the so-called “revenge” spending, driven according to some experts by the negative psychological effects that affected the population during the pandemic. 

Let's start with the economic data: 

  1. Disposable income: Biden's fiscal stimulus, along with a reduction in pandemic-related spending, has increased Americans’ disposable income:

 

  1. Consumer spending: Omicron, inflation, the Russia-Ukraine conflict and the expiration of tax credits of child tax credit. These factors  could not counterbalance the strength of the American consumer who, having more income and having been psychologically affected by the closure of the pandemic , continues to spend. Both consumption and production indices have exceeded their pre-pandemic levels in the US.
 
  1. Retail spending: The US retail sales index for January and March highlighted  a continued increase in US  consumer spending, despite  rising inflation.

 
  1. Last week's PMI shows no slowdown. The PMI is the main global economic indicator and is based on monthly surveys of a group of companies. It gives an indication of what is actually happening in the private economic sectors by tracking variables such as production, new orders, employment levels and prices. The PMIs rose in the US and Japan and fell in Europe, the latter by just one point. Here are the details:
  • The Eurozone PMI fell slightly from 55.5 to 54.4 percent.
  • US PMI rose from 56 to 58.5 %.
  • In Japan, manufacturing and services rose by 1% and 4% respectively.
  • Cina’s Manufacturing & Services fell to 49.5 and 48.4, driven by lockdowns in many cities
 
  1. Labor Market: The number of Americans filing for unemployment benefits last week fell to its lowest level in 52 years as the U.S. labor market continued to show strength despite rising costs and the pandemic. Jobless claims fell by 28,000 to 187,000 in the week to March 19, the lowest level since September 1969, the Labor Department said Thursday. Initial claims for unemployment benefits usually follow the pace of layoffs.

 
  1. Psychological effects of pandemics and revenge spending: Researchers at Harvard University surveyed over 21,000 US citizens from April 1 to May 3, 2021. About 28% of the group reported significant symptoms of depression and 25% reported symptoms of anxiety, in addition to 23% of respondents reporting suicidal thoughts.  In March 2022, the WHO also reported that global anxiety and depression had increased by 25% in the first year of the pandemic.  According to some experts, in an attempt to cope with this psychological predicament and fill the gaps left by the pandemic, Americans have increased their spending on leisure activities from 1 in December 2021 to 3 in February 2022 (+15%).

 

  1. US GDP: US GDP at +7.1%
 
Having analysed the data, let's now look at what the market thinks, by analysing two indicators that show that the risk of recession for the market is very low:
  1. What the bond market is telling us
There is a lot of talk about curve inversion, but the question is which curve to look at? Some analysts talk about the 2-10 curve, others about the 5-10 curve, and still others about the OIS curve. A very interesting paper from the Fed clarifies what to look at, comparing different types of curves and highlighting the role of the short-term spread. The spread measures the market's expectations of the Fed's short-term monetary policy path. When it increases, it means that the market expects rate hikes and when it decreases, it indicates expectations of rate cuts. This study shows how this spread best predicts three things: the recession, US GDP performance and the stock market. The fact that it is now positive and rising indicates that the probability of a recession is very low, that US GDP is expected to grow and that no major equity correction is expected.
 
 
  1. Macroeconomic indicators
Besides the US leading index, which is still expanding and therefore shows that a recession is not expected this year, another measure that better predicts recessions is the ratio of the coincident index to the lagging index. The coincident index tells you where the economy is today, the lagging index tells you where it was a few months ago.  At the start of the recovery, the coincident indicator rises while the lagging indicator falls, reflecting the recovery and pushing the index up. Before the recession, the coincident indicator starts to fall faster than the lagging indicator, pushing the indicator down. Currently, the indicator has increased after the pandemic correction and is sideways:
 
 
 
  1. The 2-10 year curve reversed on 29.03, and even after the eventual  reversal, the S&P500yearly performance is  13%
 
 
 
In light of these considerations, with economic data showing strong demand on the one hand and a market that is not in danger of recession on the other, we have no choice but to take a constructive view of the markets. In the coming weeks, the US reporting season will allow us to assess the state of corporate earnings and forecasts, but in the meantime, we remain positive on equities, particularly on the leading companies that continue to show resilience in the face of key external factors.
 
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