UBS: Persistent inflation, tight job market may hamper stock rally

Global investment bank UBS has said persistent inflation and robust job markets could put downward pressure on equities worldwide, which have been rallying since the beginning of this year.

Despite declining headline inflation, Europe and the U.S. still posted higher core CPI — a price index excluding volatile food and energy prices — in December 2022. In Europe, core prices rose by 0.7 percent, while the U.S. recorded a 0.3 percent increase. In the U.S., monthly housing costs also increased by 0.8 percent last month.

At the same time, European and American job markets remained tight. In the U.S., the average wage per hour showed an annual growth of 4.6 percent, lower than the previous month, which was 4.8 percent.

Haefele pointed out that the three-month rolling average for wage growth was 6.1 percent in December. Wage growth can further push prices up, making central banks’ combat against inflation harder.

"But it remains possible that the rally could be a ‘head fake’ and the economic data could end up disappointing."

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Mark Haefele, Chief Investment Officer of UBS

“It is still too early to assume that the inflationary threat has completely passed,” UBS chief investment officer Mark Haefele’s note read. “The possibility of underlying inflation falling below expectations remains a risk for the markets.”

Recently, two Federal Reserve officials — Cleveland Fed Chair Loretta Mester and St. Louis Fed Chair James Bullard — voiced concerns about inflation, which caused the U.S. stock market to trade lower on Wednesday.

Bullard and Mester said recent data showed that inflation had begun to slow down. However, they agree that more interest rate hikes are still necessary to bring down inflation to the target rate of two percent. According to Bullard, the terminal federal funds rate in 2023 may range between 5.25 percent to 5.5 percent.

After sharp declines in 2022, major stock indexes around the globe have shown growth since the new year. For example, the S&P 500 — a Wall Street index that measures 500 top companies in the U.S. — gained almost three percent.

In the European market, the Euro Stoxx 50 index went up by 10 percent. Meanwhile, the CSI 300 index in China posted a nearly seven percent jump. Data showed that investors mostly turned to assets that are exposed to economic improvements, such as emerging market equities.

The Chinese government’s decision to revise its strict COVID-19 prevention measures also provides support to the equity market. In China, economic data showed consumer and wholesale price inflation had started to slow down after reaching record highs in previous months.

In his note, Haefele acknowledged that investors with higher risk tolerance might wait for an “inflection point” following the rally this year. However, he advised investors not to be complacent because the economic data did not provide enough information on whether the upward trend would persist.

Recession and the stock market

Most central banks around the globe have increased their benchmark interest rates in rapid succession. This approach aims to slow down the economy and keep inflation under control.

A hawkish monetary policy, however, increases the chance for the economy to shrink and fall into a recession. In a recession, companies will have a hard time maintaining profitability and may need to lay off their workforce.

Investors will likely see companies miss their target earnings in the upcoming months due to economic contraction. Experts have predicted that developed economies will start their recessions this year, meaning that equity markets in these nations will likely plunge.

Equity analysts suggest investors begin diversifying their portfolios to deal with the risk of a stock market crash. Many investors usually place their money in safer assets, such as the greenback, which saw significant growth last year at the peak of inflation.