US Inflation Cools But Data Provides Mixed Bag For Markets.

US consumer inflation data showed prices softening in December. Greg Bonnell speaks with David Sekera, the Chief US Market Strategist at Morningstar Research, about what the most recent CPI figures might mean for the markets in 2023.

Transcript

Inflation has been the main topic for investors for a while. This latest study on US consumer costs shows that prices are slowly easing. What does this mean for markets this year? Join us today for more, David Sekera, Chief US Market Strategist for Morningstar Research.

David Thanks for having David on the show especially on an occasion like this. We’re seeing further signs that inflation is easing; however, it is still very high. What are our thoughts on this as an investor?

It seems like today can be a fantastic indicator of what we’re expecting the market to be at least over the next few months. The outlook for 2023, which we named it near-term volatility but brighter skies ahead and I’m thinking that the year ahead is likely to be a story of two halves.

I think we’ll witness some volatility during the first quarter of this year, however towards the end in the calendar, many of the headwinds mentioned in 2022 should not just be easing and then turn into tailwinds. I believe that this will allow the markets to begin recovering to the level we believe the long-term intrinsic value for the market is in the present.

Inflation being the main is evident and we’ve actually seen the reading where we’re beginning to observe–you’re experiencing a gradual decline off the high levels. It’s a sign, given that you’re outlining your plan for the year ahead, of being a long-term strategy. It’s unlikely to see drastic changes overnight. We’re going to work on it.

So in 2022, we wrote that at the beginning of the year we felt that the market was overvalued. We believe that things have been pushed towards the downside and the market is currently quite undervalued.

There were four obstacles that the market was faced with in the last year. We believe that the two headwinds are beginning to diminish. We do believe that the overwhelming majority of the growth in interest rates for long-term periods that we anticipated is over at this point.

We also mentioned that we believed inflation had reached its peak several months back, and is going down. We’re expecting 2.9 percent average inflation this year and, actually, we could be dropping to below 2% by the end of next year. The two main things that I’m keeping track of during the first half of the calendar year is the US economy as well as the Federal Reserve.

In the present, as regards the US economy, even though events in the fourth quarter of 2022 looked pretty good We do believe that the economic outlook will be a bit softer in the coming two quarters.

It will be pretty slow, and possibly even recessionary prior to it beginning to pick up speed in the second quarter and the rest of. As regards the Federal Reserve goes, it appears that we will get at least one at most two rate hikes to come before they stop.

The main reason we think that things will improve during the second half of 2012 is because we think that now that the Reserve beginning to slow down on its hikes in the last quarter of the year, they could be changing their focus back to their dual mission, which is not just about inflation, but also maximizing the economy in order achieve full employment.

US and Japan leaders discuss about security

So, in the second quarter of the year, with the economy booming and inflation decreasing and the economy stagnant during the first part of the year, it could provide them with the motivation to change their course to the other direction and, in the second quarter in the calendar year switch to a more relaxed policy.

This is the main debate, it is, as of the beginning of the year. It’s about what the Fed as well as other central banks are saying to us.

They’re saying “listen, we might have a little more in front of us and we’ll stay at this degree for a while. However, the bond market is declaring, no, we don’t believe that. We’re expecting that you’ll be cutting it off by the end of this year. Will the bond market continue to prevail in this kind of a divergence in views?

It’s true that the bond market is often referred to as “the 800-pound gorilla” in the room and you must be attentive to the bond market and its pricing. Regarding long-term interest rates, we believe we’re roughly within the range of what we’re expecting to see this year, which is 3 and 1/2 percent.

However we’ll say that as inflation is dropping particularly in the second quarter of the year and through the next year, we think there’s an opportunity for interest rates for the long-term to climb.

We’re expecting two and a half percent rate in 2024. This means that I am optimistic about the bond market is improving, and while last year was basically the worst year I’m sure we saw for fixed income, it is definitely looking better particularly during the latter half of the year for investors in fixed income.

If we get to the second half of this year in which we hope that things improve like you’re saying and when things begin to improve, what kind of bumpy journey between now and the end of the year will be when you consider the risk of volatility?

U.S. Inflation Cools But Data Provides Mixed Bag For Markets. https://t.co/olzddW2TgI #stocks #stockmarket #finance

— Seeking Alpha (@SeekingAlpha) January 14, 2023

That’s a fact, but it’s difficult to determine. However, it appears the market may have reached a low here in the US in the month of October the previous year. Therefore, I’d say that most likely to hold.

However with that said I agree with you that I would expect to observe a few percent changes in prices from day to day that are up 5%, dropping 5% most likely a trading range in the next few months.

The market is likely to be extremely attuned to economic indicators when they’re due out. Then, in the next few weeks, there’s a period of earnings beginning and I believe that people will be focusing on 2023’s guidance from a number of companies, particularly due to the release of bank guidance on the same day. In the event that the guidance is presented it could have people rethinking the valuations they base on the EPS figures.

Let’s discuss a little bit about this because clearly there have been warnings for people. Maybe the more positive argument I’m sorry it’s more bearishto this market is the lack of the firms fully releasing and saying, “OK this is the economic situation. We’ve seen a change we’ve witnessed in the activity of consumers due to rising interest rates. This is what ‘s going to affect your bottom line. We haven’t fully priced it yet. Does there have to be a reason for this argument?

Yes, there is some merit to that argument however, I have to remember whether you’re a trading or an investor. Also, when we look at the technical aspects of the market we can observe an abundance of fluctuations. The market will be attempting to manipulate the market intraday and even day-to-day, according to these economic figures.

How much higher did US inflation rise this year? Where will it be in 2023?

However, I believe that it’s a good idea to step back, as a long-term investor, take a look at what businesses could generate over the long term and think about it seriously And, as we have said using the discounted cash flow model in this.

This is why we’re trying to determine what’s the value intrinsically of the company by looking at the cash flow stream over time that it can produce? In other words, even if you experience some short-term volatility in earnings and you consider the impact that it could have on the value of the business, which is usually an earning over or under it could result in an increase of 3%-5 percent change in our intrinsic value if the outcome is different from the expectations.

In reality, we’re trying to determine whether those changes are in the business’s fundamentals in the long-term and whether or whether that alters our projections or projections.

Also, we’ll be monitoring and watching for that during the first half of the year. We’ll be watching for the estimates and based on what we’re seeing right now We believe the markets are a bit undervalued.

In fact, if we look at our valuations from the year 2010, we’re actually in unusual territory as far as the US market trades at a discounted rate in comparison to what it was before. There’s a lot of volatility expected in the near term however, for investors with a more long-term perspective that are able to weather this season of volatility, I believe that things will be better in the second quarter of the year, and into 2024.

The longer-term outlook appears to be quite positive. I’m going to ask you what might sabotage this hypothesis? What could keep it from happening in the second quarter of the year?

Our base argument regarding the US economy is that it’s likely to be in a state of stagnation to possibly recession. At this point the US economists are saying, “hey there’s a chance that an economic recession is between 30 percent to 50 percent. If that recession should happen, I’m sure that their main argument is that it’s likely to be very short and thin.

If we were in a recession that was much more serious or a recession lasting longer than the next few quarters, it would result in a significant negative pressure on earnings, and definitely down pressure on our valuations also.

Another factor that could be a wildcard is the fact that we believe that the majority of interest rate hikes over the long term are over. If we saw the 10-year bond really begin moving back up in yields, it is certainly a possibility for those stocks that are growing.

There’s a lot of downward pressure on the mega-cap growth stocks that were being pushed down in the past. Also, since there’s the market’s largest proportion of the market, it could cause market valuations to be low as well.