Inflation Has Peaked. Time To Obsess Over Growth

It’s time to worry more about growth than inflation.

Or, at the least, to consider the possibility that even if price pressures haven’t quite peaked, the market’s piqued interest in inflation now borders on an unhealthy obsession — a myopia that could leave investors unprepared for a shift in the macro zeitgeist.

“While there are many moving parts in any market environment, investors often become infatuated with one in particular,” Morgan Stanley’s Mike Wilson wrote Monday. He suggested this is most assuredly a case of infatuation, although I’m not sure that’s the best word, considering it typically entails being fond of something.

“For days leading into [the January CPI print], every conversation with investors, traders and the media seemed obsessed with the number and whether markets were appropriately priced,” Wilson went on to say, before taking a trip down memory lane.

He reminded market participants that way back in September, Morgan Stanley began warning that the Fed would be compelled to lean aggressively against red-hot inflation. “Fast forward to today and the data is irrefutable,” he declared. “Doves are quickly going extinct.”

Wilson’s victory lap came complete with an annotated visual (below).

As ever, it’s best to be wary of consensus narratives. When everyone’s on the same side of the boat, it tends to capsize.

Although Morgan Stanley is still on board with the inflation narrative, they suggested the January CPI print may have marked a near-term peak, at least in ROC terms. If that’s the case, even a slight deceleration “could reduce investors’, and the market’s, current obsession with it,” Wilson said.

So, what’s the next big thing? Well, growth. “Or the lack thereof,” as Wilson wrote Monday, noting that very much contrary to the prevailing narrative, the preliminary read on University of Michigan sentiment may have been last week’s most important data point, not CPI. Sentiment, you’ll recall, posted a “stunning” decline, with the headline gauge printing a fresh decade low (figure below).

There’s every reason to believe consumption will be relatively subdued in the near- to medium-term, notwithstanding Americans’ legendary propensity to buy things, even when they can’t afford them.

Real disposable personal income likely fell below the pre-pandemic trend last month, Build Back Better is dead, wage growth isn’t keeping up with inflation and soon enough, the moratorium on student loans will expire. All of that as the Fed is poised to embark on an aggressive tightening cycle.

That bodes ill for an economy which lives and dies by the consumer. It doesn’t help that the current conjuncture is conducive to aggressive curve flattening. Inversions can become a self-fulfilling prophecy — the optics around an inverted curve this early would be very poor indeed.

Wilson reiterated all of that on Monday.

“One of the reasons we are skeptical that the Fed and other central banks will be able to deliver on the policy tightening now expected is the fact that growth is already slowing, an unusual circumstance at the beginning of any monetary policy tightening cycle, and especially one that is so ambitious,” he said. “Whether it’s the payback in demand, or sharp decline in real personal disposable income, we think the rate of consumption is likely to disappoint expectations in the first half of 2022.”

Where does all of that leave us? Well, the jury is obviously still out. Although Morgan’s view is that the de-rating at the stock level is mostly complete, the S&P is still “about 10% too high,” according to Wilson, who thinks 18x is the destination.

However, even that relatively downbeat view is predicated on growth remaining at least a semblance of solid. “That assumption was pretty much a given for most investors,” Wilson said. “Until now.”