by Alex Harding, CFA
Vice President
Inflation was front and center this week with the release of the December Consumer Price Index (CPI) report. Inflation of 7% Headline and 5.5% Core (ex Food and Energy) were in line with consensus expectations. Both the stock and bond markets had a muted reaction on the day of the economic release as the “too much money chasing too few goods” dynamic is well-known, and most would agree annual growth rates of 37% for used cars and 50% gasoline are not sustainable. As we look ahead, the monthly trend is moving in the right direction, and we expect CPI growth to settle below 3% by the end of the year.
Although there was little reaction on the day of the December inflation report, bonds are off to a volatile start in 2022 with interest rates rising to levels not seen since last March. The upward move in rates caused a selloff in “growth” stocks, such as software and internet companies, whose value is more dependent on future cash flows. On the other hand, “value” stocks, such as banks, rallied significantly as their profit margins benefit from higher interest rates.
While the recent move seems dramatic, we witnessed this dynamic in 2021. Last year, capital markets wrestled the effects of massive stimulus and a reopening economy against pandemic-induced growth scares and higher inflation. The chart below shows how value stocks outperformed growth stocks early in 2021 as interest rates rose on positive vaccine news and above-average economic output. From June until December, growth stocks lead the way as the market faced demand-driven bottlenecks and increased COVID-19 fears. Throughout 2022, we expect both value and growth stocks to have periods of outperformance, but we are tilting towards value as we expect rates to trend higher with economic growth.
Though it won’t be a straight line, we forecast the 10-year U.S. Treasury to finish the year above 2%. As depicted below, equity valuations, measured by the S&P 500 price-to-earnings multiple, move in the opposite direction of interest rates, impacting the price investors are willing to pay for a dollar of earnings. We believe high single-digit earnings growth will offset the multiple compression leading to positive equity returns in 2022.
Takeaways for the Week
We believe peak inflation is here and will move lower throughout 2022
Value stocks are outperforming growth stocks to start the year
We hope you register for and attend our virtual Investment Outlook at 1 p.m. on January 20