Inflation fears hurt stocks
LONDON – The sharp selloff in global stock markets is being driven more by rising macro-economic risks than concerns about profit performance or the state of corporate finances, with inflation the new worry. Wednesday’s dive in particular was triggered by a US report showing slightly higher inflation than expected, lifting the core consumer price index up 2.3 percent over 12 months from a previous 2.1 percent. Modest rises like that should not normally cause equities too much of a problem because such increased costs can be passed on by companies to consumers. And 2.3 percent hardly qualifies as inflation to anyone who remembers double-digit price hikes in the 1970s and 1980s. But investors are taking a broader approach. Franz Wenzel, senior strategist at AXA Investment Managers in Paris, reckons they may be pricing in higher structural inflation, causing the risk premium on equities to rise. «It’s more of a macro thing. On the corporate side there is nothing bad about equities at the moment,» he said. The worry is that higher inflation will trigger more interest rate hikes from the Federal Reserve, which in turn will dampen consumer spending and overall growth in what is still the world-defining US economy. Some have even brought up the R-word. «Investors are wondering whether we’ll have a recession in 2007 due to a tight fiscal policy in the United States,» said Heino Ruland, a strategist at Steubing brokerage in Frankfurt. The idea of a steep downturn in growth, however, remains a minority view among investors, with most expecting a modest easing of pace globally. Some 93 percent of Merrill Lynch’s monthly fund manager survey released this week said a US recession was unlikely. At the same time, however, there was a large jump in the percentage of managers expecting higher global inflation in 12 months’ time. Equity markets have been giving investors a rough ride and volatility is up sharply. MSCI’s all-country world stock index has lost 4.75 percent over the week and its main emerging market index is off around 9 percent. It is worth remembering, however, that these losses are from a very high base after a three-year rally. Only 10 days ago, the world index hit an all-time high, while the emerging market benchmark is still up 47 percent over a year. It could just be logical profit-taking. Index declines have also been exaggerated by the tumble in heavily weighted mining and oil company stocks, previously soaring sectors that have been hit by commodity prices falling from record highs in the past week. But strategists do sense that there has been a sea change and risk aversion is on the rise. «The market’s Goldilocks view of strong growth and no inflation is replaced with a view that either growth has to slow or rates go higher, or both,» wrote Philip Isherwood, European equity strategist for Dresdner Kleinwort Wasserstein, in a note. «This is not good for equities, for cyclically-driven investments and for risk appetite.» Isherwood recommended a shift to sectors negatively correlated to risk such as consumer staples, pharmaceuticals, telecoms, utilities and retail stocks. Some of this may already be happening. State Street Global Markets said on Thursday that flow data – based on some $9.8 trillion held in custody by its parent bank – showed institutional investors reducing risk by becoming defensive. They have been selling emerging market equities and information technology stocks in favor of consumer staples and high-dividend equities. «The difference between the recent market turbulence and similar periods (last year) is that now we see unambiguous signs that investors are reducing risk,» it said. This risk reduction, however, has little to do with concern about companies themselves. Companies remain cash-rich and global equity valuations are widely considered to be reasonable to cheap. Although Merrill’s poll showed around 40 percent of investors expecting slightly lower profit growth and decreasing margins over 12 months, more than half expected corporate profits to stay at their current robust levels or even improve. The cost of corporate finance also remains low. Corporate bond spreads have gained one or two basis points as equities have fallen, but remain close to where they were at the beginning of March and near record lows. This is hardly an indicator of trouble ahead for companies. «The balance sheets of global companies are extremely fine,» said AXA’s Wenzel. «I have no problems with regards to solvency issues.»
