Stagflation Fear: Mirage or reality?
“Stagflationary” concerns overblown; inflation pressure to transit to “reflationary” as supply chain bottlenecks clear. Global concerns on stagflation have come to the fore given the uncomfortable mix of moderating growth and spiralling inflation. But to compare the current situation with 1970s/80s-style stagflation would be a stretch in our view.
The stagflationary periods of the 1970s/80s were characterised by rising unemployment and inflation. During 1973 to 1982, US unemployment rate and core inflation averaged 7.0% and 8.1%, respectively. The situation today is different. The job market has improved vastly since the pandemic, with unemployment rate standing at 5.1% with core inflation also markedly lower at 4.0%.
The global supply chain bottleneck, which has caused massive disruptions around the world, is a function of demand-supply imbalances. Lifting of pandemic lockdowns has boosted the demand for goods (from semiconductors to automobiles) with manufacturers unable to keep up given labour and logistical constraints. This drove prices higher across the board.
However, we believe the impact on inflation will be transitory given:
- Peaking of supply chain bottleneck: The global supply chain bottleneck is showing signs of peaking – for instance, (a) ISM prices has stopped rising as demand eases, and (b) Industries that benefit from the supply chain bottleneck, such as shipping and semiconductors, have started to underperform.
- Dampening of inflationary pressure as growth moderates: The medium-term outcomes of supply chain bottleneck are weaker business activities and moderating growth. This should dampen consumption demand.
Twin headwinds: Will rising energy prices and bond yields derail risk assets? Global risk assets are currently facing the twin headwinds of rising energy prices and spiralling bond yields. On energy, we expect oil price to stay elevated given demand-supply imbalances. Rising global green initiatives has led to acute underinvestment in oil fields and the supply shortfall coincided with strong rebound in demand. However, we believe the rise in energy prices will not derail the risk rally for two reasons:
1) Falling energy intensity to GDP: According to Enerdata, global energy intensity has fallen from 0.177koe/$15p in 1990 to 0.114koe/$15p by 2020 amid rising energy efficiency. This reduces the negative impact from higher energy prices.
2) No evidence of inverse correlation: Monthly correlation between oil and the S&P 500 stands at +0.55 and this suggests the absence of strong inverse relationship between energy prices and risk assets.Figure 1: Stagflations fears overblown?
Figure 2: Falling energy intensity
Source: Bloomberg, Enerdata, DBS
Meanwhile, global bond yields are expected to rise as the world emerges from the ashes of the pandemic.
As yields grind higher, a common assumption is for “long duration” stocks trading at high valuation (such as Technology companies) to underperform. The rationale here is: these companies derive a huge proportion of their value from future cash flows which will come under pressure (from a discounted cashflow perspective) as bond yields increase.
This is, however, a misconception. During the entire monetary tightening cycle from 2013 to 2018, the Nasdaq has seen vast outperformance over the S&P 500 and this suggests that rising yields have limited impact on “long duration” stocks.
Rising energy prices and bond yields – how should you position your portfolio? To navigate rising energy prices and interest rates environment, we recommend investors to gain exposure to:
- US Technology: Rising energy prices are detrimental to companies with thin operating margins and heavy reliance on energy inputs. Hence, investors are advised to gain exposure to companies with resilient operating margins, such as US Technology.
- US Financials: Rising rates and bond yields benefit US Financials as net interest margins increases.
Figure 3: Rising yields are not necessarily negative for “long duration” industries like US Technology
Source: Bloomberg, DBS
Figure 4: A rising rates environment is positive for US Financials
Source: Bloomberg, DBS
The information published by DBS Bank Ltd. (company registration no.: 196800306E) (“DBS”) is for information only. It is based on information or opinions obtained from sources believed to be reliable (but which have not been independently verified by DBS, its related companies and affiliates (“DBS Group”)) and to the maximum extent permitted by law, DBS Group does not make any representation or warranty (express or implied) as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions and estimates are subject to change without notice. The publication and distribution of the information does not constitute nor does it imply any form of endorsement by DBS Group of any person, entity, services or products described or appearing in the information. Any past performance, projection, forecast or simulation of results is not necessarily indicative of the future or likely performance of any investment or securities. Foreign exchange transactions involve risks. You should note that fluctuations in foreign exchange rates may result in losses. You may wish to seek your own independent financial, tax, or legal advice or make such independent investigations as you consider necessary or appropriate.
The information published is not and does not constitute or form part of any offer, recommendation, invitation or solicitation to subscribe to or to enter into any transaction; nor is it calculated to invite, nor does it permit the making of offers to the public to subscribe to or enter into any transaction in any jurisdiction or country in which such offer, recommendation, invitation or solicitation is not authorised or to any person to whom it is unlawful to make such offer, recommendation, invitation or solicitation or where such offer, recommendation, invitation or solicitation would be contrary to law or regulation or which would subject DBS Group to any registration requirement within such jurisdiction or country, and should not be viewed as such. Without prejudice to the generality of the foregoing, the information, services or products described or appearing in the information are not specifically intended for or specifically targeted at the public in any specific jurisdiction.
The information is the property of DBS and is protected by applicable intellectual property laws. No reproduction, transmission, sale, distribution, publication, broadcast, circulation, modification, dissemination, or commercial exploitation such information in any manner (including electronic, print or other media now known or hereafter developed) is permitted.
DBS Group and its respective directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned and may also perform or seek to perform broking, investment banking and other banking or financial services to any persons or entities mentioned.
To the maximum extent permitted by law, DBS Group accepts no liability for any losses or damages (including direct, special, indirect, consequential, incidental or loss of profits) of any kind arising from or in connection with any reliance and/or use of the information (including any error, omission or misstatement, negligent or otherwise) or further communication, even if DBS Group has been advised of the possibility thereof.
The information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. The information is distributed (a) in Singapore, by DBS Bank Ltd.; (b) in China, by DBS Bank (China) Ltd; (c) in Hong Kong, by DBS Bank (Hong Kong) Limited; (d) in Taiwan, by DBS Bank (Taiwan) Ltd; (e) in Indonesia, by PT DBS Indonesia; and (f) in India, by DBS Bank Ltd, Mumbai Branch.