Inflation raging despite global economic slowdown

Inflation data out of the US last week was slightly higher than expected, which further poured cold water on investor sentiment after a relatively encouraging start to the week. Bond yields hit new highs, buoyed by fears of recession. In the US, the 10-year yield briefly overshot the 4% mark, while the 2/10-year spread reached 50 basis points (bp). The inflation slowdown is taking time to materialise even though the global economy has been losing traction.

Oil fell by around 8% after OPEC lowered its demand growth forecasts for 2022 and 2023. WTI retreated towards USD 85 while Brent fell to USD 92.

US producer prices rose by more than expected in September, showing an increase of 0.4% versus the previous month and 8.5% relative to 12-months earlier (+8.7% in August). Consumer prices also rose more sharply than expected last month. Underlying inflationary pressures continued to build, reinforcing expectations for a fourth straight 75bp hike by the Fed next month.

At the same time, the consumer price index (CPI) rose by a faster 0.4% in September after edging up by 0.1% in August. This was higher than the expected 0.2%. Year on year, this inflation metric advanced by 8.2% versus the forecast 8.1%, having shot up by 8.3% in August. In June, inflation had peaked at 9.1% year-on-year – its highest level since November 1981.

Against this backdrop, US retail sales were unchanged in September as high inflation and surging interest rates dampened demand for goods.

The Michigan confidence index increased to 59.8 from 58.6 in September versus the economist consensus of 59.0. The component tracking consumers’ views on current economic conditions rose to 65.3, beating expectations. This was up from 59.7 in the previous month and higher than the 59.9 consensus estimate.

China’s consumer price index rose by 2.8% year-on-year in September after gaining by 2.5% in August. The producer price index rose by 0.9% year-on-year for the same month, down from 2.3% in August, versus a forecast for +1.0%.

Key for markets this week will be third-quarter earnings reports and statements from Xi Jinping at the 20th Communist party congress about the new roadmap.

Valuation benchmarks shifting in markets

Valuation multiples have descended sharply this year. By past standards, this was a swift contraction, occurring in record time – more than three times faster than in the aftermath of the internet bubble in 2000.

The S&P 500 has dropped from a P/E of 31.6x at one point in 2021 to a recent low of 17x. It had taken more than 3 years (from July 1999 to October 2002) to reach such a low ebb after the internet bubble burst. The low valuation exhibited by the S&P 500 stems from the proportion of stocks with a P/E of less than 10x. These now represent more than 21% of the index. By comparison, during troubled times in 2018 and 2020, this ratio rose to 24% and 30%, respectively.

US midcaps have so far performed in line with large caps (-25% for the S&P 500 and Russell 2000, -32.7% for Nasdaq) as the rise in interest rates has hugely impacted tech large caps, which were richly valued, having been boosted by the Fed’s low-rate policy.

Strong performances by tech, luxury and cyclical stocks were the driving force behind the spectacular showing by equity markets in recent years. That is why indices have become far more sensitive to the sharp rise in interest rates seen recently. In the US, rates have risen by 300bp in just a few months, causing markets to head south. Underperformance by tech- or cyclical-heavy indices (such as the Nasdaq or the SOX semiconductor index) perfectly portrays the rapid rise in risk aversion and implies a strong slowdown (which may not even occur).

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