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The issue of rising prices has gradually infiltrated the conversations of major economic stakeholders in the US, penetrating first the hushed offices of the Fed, and then corporate board rooms. And now this topic is being discussed around dinner tables across the country. Although unexpected, this is quite appropriate, as one of the few leading indicators available today for the entirety of 2021 – the consumer price index (CPI) – highlights the rise in consumer prices for the year. It shows inflation of 7.1% for 2021 versus 1.3% in the previous year: this represents the sharpest rise in almost 30 years, but also the strongest annual acceleration in close to 40 years! Such a dramatic change is bound to create some collateral damage and benefits.
It’s something of a cold shower for employees in the US. The 4.7% rise in weekly wages that makes them the envy of their European counterparts is just not enough when the price of the average household basket has risen by 7.1%. This means they are 2.4% worse off in real terms. In theory, the situation is more galling still for students and pensioners.
Although the Fed initially believed this pricing pressure to be temporary, it has been forced to abandon this inept description and to prepare itself to tackle the phenomenon head on as its mandate dictates. So it is preparing to raise interest rates four times this year, starting in March. In parallel, the central bank will put a halt to the expansion of its balance sheet via asset purchases. Some of its board members are even expecting five rate hikes in 2022, indicating how urgent they consider the situation.
For companies, although inflation is having a major impact on their cost base – production prices rose by 9.7% in 2021 – we are witnessing an exceptional year for earnings. In anticipation of the final Q4 figures due to be published in the coming weeks, the consensus is for a rise in turnover of 12.5% for S&P 500 companies, i.e. ahead of their input prices. Corporate earnings are likely to explode, with expected growth of 48.7%. So companies are the major winners of the phenomenon at this stage. With high levels of available funds, they thus have the leisure of investing, considering strategic acquisitions to prepare for the future, or rewarding their shareholders with higher dividend distributions or share buy-backs.
To date, there looks to have been a strong price-earnings spiral. But inflation may prove persistent, driven by the real estate market remaining tight, or a COVID-19 wave paralysing the world’s factory, China. Worst of all, it could prove self-fuelling on the back of rising wages as labour shortages are likely to result in tougher wage negotiations. In other words, after a price-earnings spiral, we risk seeing a wage-price spiral materialise.
Written on 14.1.2022 by Olivier de Berranger, CIO and Clément Inbona, Fund Manager