Without a doubt, this year investment in stocks has been largely harmed by the effects of the inflation. We have come to see figures such as 9,1% of the US economy (levels not seen in 40 years) or in the old continent we managed to discover both figures (10,6% in the month of October). However, the results on the US CPI announced yesterday already showed signs of calm in the great storm that we have experienced in 2022. Many believe that we have already reached the peak of inflation and that the following year will be marked by a deflationary period that could lower the pressure on prices to reach the target 3-4% at the end of the next academic year. Let's see what factors can drive this cooling of inflation and how they will benefit investing in stocks.
1. Situation of global supply chains.⛓️
Globally, supply chains suffered a crisis caused by the impact of the 2020 pandemic. This event caused the closure of factories which, in turn, the lack of labor increased bottlenecks and multiple delays occurred in deliveries. This ended up causing large increases in production costs, in part due to the paralysis of thousands of ships loaded with containers in the middle of the sea waiting to unload the goods. Luckily, that era has already been showing signs of recovery, where delivery times are faster and transportation costs are cheaper, benefiting companies and, above all, the stock investment sector.
The Federal Reserve's (Fed) Global Supply Chain Pressure Index is a useful indicator for checking the health of supply chains. This index combines data on shipping costs, delivery times and delays of manufacturing companies in seven interconnected economies: China, South Korea, the United States, the euro area, Japan, Taiwan and the United Kingdom. Since the beginning of the year, the index has already fallen by almost 80%.
2. Correction of the imbalance in the money supply.⚖️
With the Fed buying government bonds in a strategy aimed at lowering yields known as "quantitative easing" (which we discussed the other day in the article about central banks), and with the government handing out different rounds of stimulus checks during the Covid crisis, an imbalance in the money supply occurred. In part this was one of the great catalysts for the increases in stock investment prices. To solve this problem, they have applied a series of aggressive interest rate increases and applied a “monetary adjustment” in terms of State bonds, that is, they are taking money out of the system, which tells us that inflation should go down.
Comparison between the interannual variation of the M2 monetary supply and the interannual variation of the US CPI (in %). Source: Bloomberg, Morgan Stanley.
The following graph shows the general CPI (blue line) and the M2 money supply forward to 16 months (yellow line). Both usually move in tandem, which could indicate that the CPI could fall in the next 16 months, following in the footsteps of the monetary supply. Of course, let us remember that interest rate increases take time to reach the real economy. The Fed has tightened aggressively this year, so this should have an effect throughout 2023.
3. Inflation drivers have eased.️
There are different factors that we have been dragging along since the coronavirus pandemic of 2020 occurred. These factors are those that have increasingly fueled inflation to levels not seen for a long time in the global economy and consequently harmed investment in stocks:
Problems with global supply chains.️
As we mentioned in the previous paragraph, the pandemic has largely harmed retailers, who have placed excessive orders to compensate for possible supply chain problems and have overestimated demand. Now they have too much supply, which translates into discounts that end up fueling inflation again. For example, the textile retail sector during the third quarter of this year in view of the Christmas period has a negative adjusted differential close to -15% in the relationship between sales and available inventory.
The oil price surge. ️
The war in Ukraine caused a sharp spike in energy prices this year. The invasion and resulting sanctions caused disruptions in the supply of oil From Russia. Reduced supply and steady demand drove prices higher.
The slowdown in the global economy is likely to reduce demand for oil, so we can expect oil prices to remain lower as well. Oil is currently trading around $76 a barrel, down from 2022 highs of around $130, and if it remains at this level, it will have a negative impact on inflation next year.
Rising food prices.
The war also raised food prices. Russia and Ukraine represent more than 30% of world wheat exports, so the war affected this supply without other countries being able to plug the hole. However, a Black Sea grain deal has helped ease these supply pressures, and has already driven down prices. We can consult the development of food prices through the FAO page, with which we did an article on our old blog on Substack.
The semiconductor crisis.
The pandemic also caused some price imbalances, for example in car sales. Factory closures caused a shortage of semiconductors (topic that we discussed a few months ago in an article) necessary for the manufacture of new cars. This led to fewer cars being manufactured, and as more and more people bought cars to avoid public transport, the price of second-hand vehicles skyrocketed.
Prices accelerated by almost 50% in June 2021, compared to the previous year, but now those increases are very neutral. In November, used cars are down 16% from peaks.
The real estate sector.️
Finally, there is the real estate, which tracks rental prices. This is the factor with the most weight, since it represents close to a third of total inflation, and its prices seem to be reaching a ceiling. Data from Zillow and Apartment List, known for accurately forecasting housing costs up to 12 months in advance, point to lower market prices for future rentals. And that cooling is likely to show up in US CPI housing costs in early 2023.
4. The labor market with signs of recovery.⚒️
It is increasingly taking longer for the working-age population to enter the workforce and the growth in early retirements has produced a reduction in the supply of labor. Job openings and attrition rates have decreased recently, indicating lower demand for workers. At the same time, we have seen how the investment sector in company shares, especially in the technology sector, has drastically reduced its workforce.
Atlanta Federal Reserve's year-over-year wage growth indicator in percentage. Sources: Atlanta Federal Reserve.
It has also been seen that the Atlanta Fed's wage growth indicator appears to have peaked at 6,7% compared to the previous year, as the latest data stood at 6,4% compared to the previous year. last year.