Disinflation: Two positives for the equity markets-4 December 2023
Inflation is now visibly easing. This trend means that both the interest rate and economic outlook have improved, which is good news for the equity markets.
Recent financial market movements have confirmed that investors still consider inflation as “another name for risk”. The excellent inflation figures in the eurozone and the United States have therefore logically led the prices of risky assets to jump. In November, eurozone inflation, which has been moving in the right direction for several months, all but vanished, dropping to +2.4% year on year. Core inflation, which excludes food and energy, remains a little higher at +3.6% year on year, but it too has developed favourably over the last three and six months (chart 1).
Some members of the European Central Bank are still talking about future risks linked to wages, but this tends to be a lagging indicator. The expectation that the ECB will start lowering its interest rates next spring at a rate of 25 basis points every two months has already been priced in by the financial markets. This is not at all unrealistic, especially since the ECB does not want structural inflation to return to the overly low pre-pandemic levels of around +1.25%. However, to get a better idea of how likely interest rate cuts are, we will need to monitor the trajectory of the economic recovery expected in the eurozone in 2024, as well as its potential impact on inflationary pressures. The key point remains: Disinflation has improved the outlook for both interest rates and growth in Europe, thanks to increased purchasing power.
For now, there continues to be a strong positive correlation between the global stock markets and the bond markets, as has been the case since midsummer (chart 2). It is worth noting, however, that equities have slightly outperformed sovereign bonds since the start of November, which seems logical. Barring a recession, it is highly unlikely that sovereign bonds, whose yields remain low compared to money market instruments, will outperform equities. Furthermore, the increased likelihood of short-term interest rates falling in 2024 may only have a marginal effect on long-term interest rates, as the yield curve recovers. Finally, in a scenario of moderate global growth without inflation, equities benefit from both reduced interest rate fears and greater confidence in the prospect of sustained growth.
We will continue to need to monitor the probabilities associated with a more complex scenario, which sees expectations of growth continue to rise for the part of the world where, on the contrary, a slowdown is desirable: the United States. While this scenario may seem far less dangerous now that US inflation is close to Fed targets, it could cause investors to question the appropriateness of monetary easing next year. Indeed, US consumption remains quite high and gains in purchasing power are accelerating. It is also quite likely that the period of manufacturer inventory drawdowns that has been underway for several months will soon end, making room for a recovery in the manufacturing sector, both in the United States and in the rest of the world (chart 3).
We are maintaining the overweighting of equities in our global funds. Our bond duration remains positive but still quite modest. Money market instruments continue to be the main driver of regular returns.
[Download the weekly letter in PDF version: Exposure rates of the Dorval Asset Management Range – 4 December 2023] (https://site-dorval-production.s3.fr-par.scw.cloud/uploads/weeklynote_en_20231204_1005a2ac6d.pdf)