Weaker-than-expected U.S. inflation data sent global markets soaring Thursday, shoving the MSCI World Index higher by more than 5 per cent. But by Friday morning, prominent strategists were falling all over themselves to warn investors not to chase the rally.
Lisa Shalett, chief investment officer for Morgan Stanley Wealth Management, said in a note that investors looking for a new bull market were “woefully early.” Ms. Shalett notes that there is no confirmation of a peak in wage, rent or services inflation and the Federal Reserve is watching there measures carefully.
More importantly, the economic effects of monetary tightening are felt with a lag of between six and 18 months, so the previous rate hikes are only now starting to slow economic growth. Morgan Stanley believes profit growth is set to slow as a result and stock prices have yet to price this in. “The impact of an economic slowdown on earnings - when both volumes and pricing power wane - has not yet been absorbed or reflected in forward estimates,” Ms. Shalett wrote.
Scotiabank strategist Hugo Ste-Marie is similarly cautious. In a Friday update he emphasized that even if inflation pressure was easing, it remained at levels that will damage future market returns. He pointed to futures markets that predict core inflation of roughly 4.5 per cent for 2023, a rate that for him implies limited equity market returns.
BofA Securities U.S. quantitative strategist Savita Subramanian also has concerns about profit growth. She wrote that “if inflation is cooling because of waning demand (especially in goods, which represent 50 per cent of S&P 500 EPS vs. just 20 per cent for the economy), earnings cuts will likely deepen.”
Ms. Subramanian also noted that new bull markets have historically not kicked off until almost a full year after the Federal Reserve began cutting interest rates. Central bank rate increases are expected to continue well into 2023, after which the Fed will pause and carefully monitor the economic fallout. The first rate cut is a long ways away.
The high number of strategists urging caution on Friday leaves me conflicted. It’s tempting to be contrarian – it is an old market saying that whenever everybody thinks one thing will happen, another thing will. But, Morgan Stanley’s longstanding fear that stock prices do not yet reflect the coming profit slowdown is one I share. Personally, I will be avoiding economically sensitive market sectors in the coming months while searching for growth opportunities.
-- Scott Barlow, Globe and Mail market strategist
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