Growth recovery without rising inflation: having your cake and eating it too?

Humanity has perhaps never been so aware of its dependence on the climate.
First of all, there is a scientific awareness, joined by an empirical awareness, a universal perception, which is spreading to the whole species, of the danger, of rising temperatures, of the volatility and brutality of meteorological phenomena.
A historical awareness as well, with, in the course of their research, the excavation of evidence of the climatic causality of the fall of ancient civilisations…
Among them, the Hittites, according to an analysis of the girths of trees in Anatolia, recently published by the journal Nature. 

It is difficult to say whether the three years of drought (between 1198 and 1196 B.C.) noted by this study would have been enough to precipitate the citizens of Hattusa into exodus and condemn one of the greatest civilisations of the region. But the hypothesis of a 200-300 year period of drought causing a 40% drop in rainfall between the end of the Bronze Age and the beginning of the Iron Age is gaining ground.

The cascade effect of such climate change (exiles and migratory flows, upheavals in societies, geopolitical tensions and reduced harvests) is reminiscent of the one that threatens us today. After an absence of three years, the return of El Nino could be aggravated by the slowing down of the Gulfstream, which seems to be playing less and less of its role as an ocean thermostat. This highly calorific combination could push temperatures above last year’s records.

Focused (for now) on more virtual thermodynamics, investors are struggling to keep the thermostat at the maximum risk-on position. The upward momentum[1] in equity[2] markets is slowing as interest rates rebound and the growth-inflation-valuation equation becomes more complicated.

With inflation slowing less than expected, leading to higher interest rates, the justification for the excessively low equity market risk premium is earnings growth, and hence economic growth.

The Purchasing Managers’ Index (PMI[3]) is an important tool for forecasting business sentiment and GDP growth, as it takes the pulse of companies’ purchasing functions and the feelings of those responsible for restocking and placing orders with suppliers with a view to increasing sales.

This data, which has now risen for four consecutive months, came in well above expectations and the fateful 50-point threshold in January.

Activity in the services sector is particularly resilient. It seems to reflect the fact that, at the beginning of the year, the rebound in household confidence is benefiting consumer-oriented businesses.

On the other hand, manufacturing activity remains at half-mast, despite the reopening of China.

However, the ratio of new orders to inventories remains stable.

Investors will nevertheless have to ask themselves whether the scenario of a recovery in economic activity is fully compatible with the scenario of falling inflation valued by the markets. Can inflation really be beaten when activity is already resisting or recovering?

The balance is all the more delicate as core inflation in the Eurozone remains higher than expected. Echoing the good performance of the Services PMI, it shows that upward pressure on prices is persistent, despite the sharper than expected decline (-0.4%) in German growth in the fourth quarter and the ECB’s more restrictive monetary policy.

In the current context, hoping for a rebound in the economy and profits without the damage of inflation and higher interest rates is a bit like wanting the butter without the price. Between the hope of a low point already confirmed in business and that of a definitive peak reached on inflation, the markets are now leaving themselves less room for unpleasant surprises… While the year 2023 should remain rich in economic, geopolitical and unfortunately climatic twists and turns…

Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in February 24th, 2023.

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Termes et définitions
1. momentum. Le momentum est une mesure quantitative qui indique la vitesse et la quantité de mouvement d’un actif ou…
2. equity. Equity est un terme qui désigne une forme d’investissement à long terme dans une entreprise. Lorsqu’un investisseur achète…
3. PMI ( PMI ) L'indice PMI (Purchasing Managers' Index) est un indicateur mensuel qui mesure la performance des secteurs de l'industrie manufacturière et des services.
Mégatendances : Le marché automobile, reflet de l’économie mondiale
Chine : un bon début d’année 
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