SUMMARY
Investors expect the current environment to persist. However, we believe cash-heavy consumers, supply chain bottlenecks, labor dislocations and pandemic-shortages are not going to be permanent fixtures of our economy.
Investment strategy
November 1, 2021
Working overtime: Our views on inflation and earnings
November 1, 2021
- There is a widely held belief that inflation caused by the extraordinary events of 2020-21 will remain. That is unlikely but inflation in the coming decade will trend higher than in the decade past. The current CPI inflation view embedded in TIPS is +2.6% per year. We consider that a good proxy for forward US inflation.
- A combination of higher future inflation and persistently lower interest rates creates a poor forward environment for fixed income investors. Over the past decade, the US 10-year Treasury note’s total return after inflation was +5.1%. Using US Treasury Inflation Protected Securities (TIPS) as a proxy, the real total return of the 10-year Treasury is likely to be negative 10% over the coming decade.
- Analysts continue to underestimate the strength of S&P 500 earnings recovery after an 11% profit decline in 2020. We expect estimates to continue to be revised higher for the remainder of the year. Outside the US, two-thirds of European companies have beat consensus thus far. A growing percentage of global earnings downgrades can be found among Chinese firms, as investors price in a deceleration in China’s macro situation.
- We forecast an 8% EPS growth rate for the US and world in 2022 vs 45% in 2021. However, upside “surprises” in 2021 make downgrades to EPS estimates in 2022 less likely. In short, 2022 earnings performance looks more certain, not less.
- The Consumer Staples sector has posted the second slowest growth rate of all sectors in the current reporting period with shares lagging the S&P 500 by about 16 percentage points in the year-to-date. In 2021, these firms had stable sales and incurred sharply rising costs. The 2022 outlook for such shares should improve if costs stabilize, as we expect. Meanwhile, the doubling or more in profits for commodity-related sectors over the last year seems set to slow in the year-ahead.
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