Macro Insights: Soft landing or not?

Surfing today’s macroeconomic wave — Inflation

Imagine the sea. Most of the time, it is calm. But occasionally, a storm brews with high waves, leading authorities to close the waters for sailing. We view the macro context in the stock market similarly. Typically, economic conditions are stable, but fiscal and monetary forces are occasionally mobilized to address economic challenges. This section aims to enhance your understanding of macro and its impact on the stock market.

While it's common to forecast the future by extrapolating past patterns, this approach often fails. Understanding the cause and effect behind each specific situation is more effective, although this is always challenging. Let’s focus on the current situation and explore potential scenarios that could influence decision-makers as stock investors.

Currently, inflation is a major concern, acting as a significant wave in our metaphorical sea. The major economic powers contributing approximately 60% to global GDP—namely the US, EU, and China—define this sea. In the EU and China, inflation is no longer a problem, and in China, deflation has even begun. It is now the US’s turn to reach its long-term inflation target of around 2%, ensuring the world exits this high inflationary period in good shape without a significant drop in GDP. This scenario, known as a soft landing, is the base case today and is predicated on assumptions of continued economic growth and rising corporate profits, driving stock prices higher.

The Federal Reserve targets Core PCE with a long-term annual rate of 2% and may start cutting the funds rate if it observes robust movement towards this target. However, in recent months, the pace of reaching this target has slowed, and markets have begun to price in stickier-than-expected inflation, pushing potential rate cuts to the second half of the year.

Monitoring inflation rate releases is crucial, as persistent or accelerating inflation could impact companies' margins and lead to downward revisions in earnings, which could be a painful no-landing for the markets.

Moreover, a sharp decline in inflation could also signal trouble, indicating a sharp decline in demand and a potential recession or hard-landing scenario. In such a case, the Fed may be forced to cut rates chaotically in an attempt to sustain economic growth. If these rate cuts are delayed, we might see earnings revisions due to decreased demand and economic growth, which would also be detrimental.

For us, stock pickers, any scenario is manageable, as there are always stocks that rise, and good research can help us identify them. The critical task is to determine promptly which scenario will materialize. We will see it soon, stay tuned.