Stocks maintain their upward momentum as UK inflation expected
The big news is that equity markets held their nerve at the end of last week, even after the upside surprise to US inflation for October. While US bond yields have jumped on the back of the rise to 6.2% in annual US CPI, US Treasury yields did not make it back to their 2021 highs, and there is still lots of disagreement out there about whether or not inflation will be temporary. For what it’s worth, we think that inflation rates will start to fall in Q2 next year, as annual comparisons reflect well on the 2022 inflation rate. However, US Treasury secretary Janet Yellen, has said that inflation will only get under control when Covid is under control. Thus, if you think that inflation will kill the positive vibe in stock markets, and if you are a perma-bull, go get your booster Covid jab, folks!
We are looking at three things that will be key drivers of markets this week: economic data, earnings releases and some important corporate news in the UK and Europe.
1, Economic data
The key release to watch is UK inflation data on Wednesday, which could show that consumer prices will hit 3.9% for October, the highest level in a decade, as supply chain woes, rising energy prices and wages all conspire to push up prices. Headline CPI was 3.1% in September, thus if UK inflation forecasts are correct then October was a month of huge price rises on both sides of the Atlantic. The issue for traders is whether this is “good” or “bad” inflation. We think that UK inflation is driven by extraordinary levels of demand for services, which should be reflected in this CPI reading, we also believe that prices will continue to climb, with inflation rising above 4% in November and peaking at 5% in the spring, in line with BOE forecasts. The BOE bottled the chance to raise interest rates earlier this month, and one reason for this was the evolution of the labour market. The Bank of England is concerned that the end of the furlough scheme will push up the rate of unemployment, although the labour market has generally been strong throughout the covid crisis. Since labour market data is a lagging economic indicator, we believe that this will buy the BOE some time and they will not rush to signal that they will raise interest rates in the near term, which is what they did in October, only to wrong-foot financial markets at their meeting earlier this month. We will be looking at the FX market closely in the wake of the UK CPI data on Wednesday. It is worth noting that the dollar surged on the back of stronger than expected US CPI last week, and this sent GBP/USD lower, it reached a low around $1.3350 on 12/11. However, it is interesting that GBP is in recovery mode at the start of this week. It is back above the $1.34 handle; however, it has not been able to sustain an attempt to take $1.3450, and we do not think that this will happen ahead of the inflation report on Wednesday. But, if inflation is stronger than expected, then we could see GBP surge, so GBP bears beware.
US retail sales are also released this week. Sales are expected to have increased in October relative to September, as covid levels stabilised and as the US consumer prepares for the holiday season. It is worth remembering that the US consumer remains in a relatively strong financial position, and consumers are also worried about supply chain issues, so they are starting Christmas shopping earlier than in prior years. Sales are expected to increase by 1.2%, with core sales rising 1%. However, there is still a risk that congestion at some of the biggest ports in the US could limit supply in this crucial season for the retailers, with analysts expecting clothing and accessory sales to be the worst affected by the supply chain woes. However, if consumers cannot find what they want they are likely to shift spending to services. So, even if we get weaker than expected retail sales on the back of supply chain problems, we still think that the US consumer will be an important part of overall US growth in Q4, and we do not think weaker retail sales will hurt US stocks in the near term.
2, Retail earnings reports
More important for the outlook for US consumer stocks in the near term, will be this week’s earnings reports from Walmart, Target, Home Depot and Lowes. Retail stocks have generally been trading well in the lead up to these reports as the value trade in the US is back on. The market is expecting a $24.6bn in revenue from Target, $135.7bn from Walmart, $34.5bn from Home Depot and $21.6bn from Lowes. Home Depot and Lowes have performed extremely well as the trend in home improvements continues to grow. We will be looking to see if these firms can top revenue and earnings expectations, and whether or not the leadership teams can navigate the tricky situations with the supply chain crisis. If we do get any upside surprises, and good news about the supply chain crisis, then expect these retail stocks to continue to rise and we may even see record highs for some of them including Home Depot, which we have high hopes for.
3, Corporate news
Two non-earnings-related corporate news stories caught our eye at the start of this trading week. Firstly, Shell is moving its HQ to London along with its tax base, and ditching its dual share structure, with shares sold in London, Netherlands and the US. Shell is currently under an attack from activist investor Third Point, and we think that this move is designed to prove to the market that Shell is serious about its competitiveness, its dividend and its pledge to become a zero emissions business. The move could allow share buybacks to double, and it may also be linked to the court case it is facing in the Hague to accelerate its emissions reductions. Its share price is up 0.7% on Monday, and is outperforming the overall UK market, in a sign that the market is moderately pleased with this news. We think that the share buyback news is positive for Shell’s share price in the medium term, as we may continue to see further gains through to year-end on the back of strong oil prices (even though the oil price is down more than 1% at the start of the week due to the COP 26 agreement). We are also positive on Shell’s share price because we think that Shell will accelerate its plans to go green in an effort to keep up with some of its European rivals.
Elsewhere, we also thought that the Deutche Bank CEO’s call for central bankers to tighten monetary policy was worth looking at closely. He warned that central bankers were behind the curve on inflation and this could lead to risky side effects. Christian Sewing said that low interest rates were no longer effective at a conference in Frankfurt on Monday. It is unsurprising that a banker is unhappy with the ECB’s negative interest rate policy since it erodes banks profit margins, however, this public criticism is still rare, and it could make the ECB take note. So far, the ECB are not willing to take the DB chief’s advice, and Christine Lagarde said on Monday that upward pressure on inflation will continue to be temporary. DB’s share price is up 0.4% on Monday and it is trading in-line with the broader market. Its share price is in an upward trend, but it continues to underperform its US rivals including Bank of America, and Lloyds in the UK, as you can see in the chart below. We think that this trend will prevail, as the ECB is likely to be the last of the major central banks to normalise monetary policy, in our view.
Chart:
