The US yield curve flattened bearish. Profit growth, meanwhile, remains stronger than expected. Overview.

In the United States, in October, consumer price inflation stood at 6.2% year-on-year, the highest since November 1990. Energy and food prices were a major contributor but apart from these expense items, core inflation still stands at 4.6% over one year.

In addition, the yield spread between thirty-year and five-year securities narrowed by 5 basis points (bps), to 68.5 bps on the day of the publication of the Consumer Price Index ( IPC). We have to go back to March 2020 to find such a small gap. Now, the markets are counting on a first hike in key rates by the US Federal Reserve (Fed) in July 2022. The S&P 500 index fell but last week it ended at just 0.4% of its all-time high .

Each publication of an inflation figure above expectations risks creating new bouts of volatility in the fixed income and equity markets.

Finally, as the third quarter US earnings season draws to a close, the number of companies reporting higher-than-expected profits is above average.

How to interpret the situation?

  1. The fear of monetary tightening
    The brief bout of volatility ten days ago in equity markets and the bearish flattening of the U.S. yield curve (when short rates rise more than long rates) reflect fears of further monetary tightening. marked likely to stifle growth. Each publication of an inflation figure above expectations risks creating new bouts of volatility in the fixed income and equity markets.
  2. Inflation reduction in 2022
    Inflation is proving to be more generalized and more lasting than expected. The next few months should therefore still be marked by figures above estimates on this front.
    Nevertheless, the basic scenario of UBS Research is still that of a fall in inflation in the course of the next year with the gradual absorption of the imbalance between supply and demand, the stabilization of prices of energy, as well as with the acceleration of the return of the unemployed to the labor market. This will ease the pressure on consumers, on interest rates and on businesses. And it will also create a favorable context for equities.
  3. The patience of the Fed
    Faced with an uncertain economic environment, the Fed will likely be cautious. Thus, it should still be patient before raising its rates. At the end of its meeting in November, the central bank stressed in particular that economic data, both on the inflation front and on that of employment, were distorted by the pandemic and that politicians had to avoid overreacting.
    So while higher inflation will test the patience of Fed officials, they will be keen not to penalize the economy with premature monetary tightening that stifles growth.
  4. Higher than expected profits
    The Fed’s approach should therefore allow investors to remain focused on solid corporate fundamentals, which is likely to fuel the rebound in equities. 92% of S&P 500 companies published their third quarter results: 80% of them beat forecasts, compared to 76% on average over the past five years. Despite the supply difficulties, sales were up 17% year-on-year and were 2% (median) above estimates.
    Strong demand allows companies to pass on higher costs. In fact, in the third quarter, the profit margins of S&P 500 companies remained stable at a historically high level. Overall, third quarter profits are up more than 38% year on year, 10 percentage points better than expected.
    In Europe, around 89% of companies have published their results and 72% of them have announced a profit above estimates. Globally, UBS Research expects earnings per share to grow 43% in 2021 and 9% in 2022. Given the strong corporate results, equities are likely to be on the rise in this area. forecast horizon.
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It is recommended to focus on stocks that are expected to surf global growth.

What does this mean for investors?

While the S&P 500 Index is still flirting with all-time highs, strong GDP and earnings growth, coupled with accommodative policies, should outweigh inflation concerns and keep stocks moving higher. It is recommended to focus on stocks that are expected to ride global growth, especially those from the energy and financial sectors, US mid caps, as well as Japanese and euro area stocks.

While inflation is expected to remain high for a few more months and rates are expected to remain low, destruction of wealth is a likely outcome for those holding high-quality cash or bonds. Nevertheless, it should be possible to reap a positive real return with US senior loans, Asian high-yield bonds, certain currencies, as well as with other unconventional sources of return such as unlisted debt.

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