Throughout 2023’s second half, financial publications Fisher Investments UK reviews touted cooling European and US inflation (broadly rising prices across the economy). Yet price levels for many goods and services remain above prepandemic times.i What is happening here? We have seen this seeming disconnect fan understandable frustration amongst many: if inflation is cooling, why aren’t things getting any cheaper? In our view, understanding disinflation versus deflation is key. In doing so, we think investors can see why still-elevated prices don’t threaten equities.
A distinction worth being aware of, in Fisher Investments UK’s review: inflation is a rate of change, not a level. That is, inflation reflects the pace of prices’ increase (or decrease) compared to some prior period – usually the prior month or year. Consider the eurozone’s Harmonised Index of Consumer Prices (HICP). Its 2.4% y/y (year-over-year) rate in November 2023 represents eurozone goods and services prices’ overall increase from November 2022’s.ii HICP’s -0.5% m/m (month-over-month) dip signifies November 2023 prices’ decrease relative to October 2023’s prices.iii
The inflation rate can fall from month to month, but if it remains positive, it means prices are still rising – just at a slower rate. This is called disinflation. Eurozone inflation slowing from October 2022’s 10.6% y/y peak to November 2023’s 2.4% is a classic example of relatively large disinflation.iv America’s 9.1% y/y inflation peak in June 2022 slowing down to 3.1% in November 2023 is another.v
On the other hand, deflation refers to prices actually falling. Deflationary periods mean lower absolute price levels and, hence, negative inflation rates. Based on financial commentary Fisher Investments UK reviews, that is the scenario many seemingly want now – that is, for goods and services price levels to fall after 2021 – 2023’s rises, returning to something closer to prepandemic levels.
Whilst deflation might sound appealing – i.e., cheaper groceries and energy bills – we have found it is a side effect of bad economic times. Based on our research, it is historically rare – thankfully so, in our view. One deflationary period that sticks out in Fisher Investments UK’s reviews of economic history? The Great Depression – an era of widespread unemployment and economic decline in America and Europe.vi Consider US data (which we cite for its long history and availability) from the period: on an annual basis, America’s Consumer Price Index (CPI) contracted -2.7% y/y in 1930, -8.9% in 1931, -10.3% in 1932 and -5.2% in 1933.vii Deflationary forces didn’t help equities: in price terms, America’s S&P 500 fell -28.5% in 1930, -47.1% in 1931 and -14.8% in 1932, before eventually delivering positive full-year returns in 1933.viii We think equities were pricing in the same economic problems that drove the deep deflation – namely, severe global banking problems and the acute contraction in money supply.ix
The 2007 – 2009 global financial crisis featured deflation, too. Eurozone HICP contracted from June through October 2009 (hitting a low of -0.6% y/y in July 2009) whilst America’s CPI shrank from March 2009 through October 2009 (bottoming at -2.1% in July 2009) – all amidst a global recession (a period of contracting economic output).x The eurozone also experienced moderate deflation during 2020’s COVID-induced economic shutdowns: HICP contracted on a year-over-year basis from August 2020 through December 2020.xi Fisher Investments UK thinks it is safe to say these weren’t economic or equity market boom times, with major US and European equity indexes enduring bear markets (equity market declines of -20% or worse) during these periods.xii
Then, too, we think it is important to consider the massive hypothetical deflation required for today’s prices to return to pre-2020 levels. The eurozone would require a cumulative deflation of -14.9% to pull November 2023 prices back down to December 2019 levels.xiii America would need cumulative deflation -16.3% to get back to prepandemic levels.xiv Such deflation would be comparable to the Great Depression’s – and, in Fisher Investments UK’s review, would mean similar economic negativity. We don’t think those hoping for deflation today want that – nor the associated unemployment, emotional turmoil and overall reduced quality of life we think would arise.
As for still-elevated prices now, we understand their sting on household budgets, but we think their threat to equities is limited. We have found firms and consumers adapt, as 2021 – 2023’s inflationary stretch illustrates, in Fisher Investments UK’s opinion.xv Eurozone firms remain resilient, with profit margins across the bloc a healthy 24.9% through Q3 2023 – allowing these companies to finance from within and grow despite higher costs, in our view.xvi US firms’ profit margins through Q3 2023 are even larger – 33.2%.xvii Furthermore, we think wage growth outpacing inflation can help offset inflationary pressures. The data show that happening – with the eurozone’s 4.5% y/y wage growth in Q2 2023 outpacing eurozone HICP over the same period.xviii Similarly, US wage growth outpaced American headline CPI from February 2023 through November 2023 (the latest data available).xix Fisher Investments UK thinks this gives households some of their purchasing power back and likely continues, as wages regularly follow inflation, according to our research.
Whilst we sympathise with consumers and businesses contending with higher costs, Fisher Investments UK doesn’t think deflation would benefit them – or equities.
Disclaimer:
This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or a reflection of client performance. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Nothing herein is intended to be a recommendation or forecast of market conditions. Rather, it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. In addition, no assurances are made regarding the accuracy of any assumptions made in any illustrations herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square (NYSE:SQ), Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
i Source: FactSet, as of 13/12/2023. Statement based on Eurozone Harmonised Index of Consumer Prices (HICP) and US Consumer Price Index (CPI), December 2019 – November 2023. HICP and CPI are government-produced indexes tracking prices of commonly consumed goods and services.
ii Source: FactSet, as of 12/12/2023. Eurozone Harmonised Index of Consumer Prices.
iii Ibid.
iv Ibid.
v Source: FactSet, as of 12/12/2023. US Consumer Price Index.
vi Source: United States Department of State, Office of the Historian, as of 12/12/2023. “The Great Depression and U.S. Foreign Policy.”
vii Source: FactSet, as of 12/12/2023. US Consumer Price Index.
viii Source: FactSet, as of 12/12/2023. S&P 500 Index (price returns), 12/31/1929 – 12/31/1933. Presented in US dollars. Currency fluctuations between the dollar and the pound may result in higher or lower investment returns.
ix Source: United States Department of State, Office of the Historian, as of 12/12/2023. “The Great Depression and U.S. Foreign Policy,” and “The Great Depression,” Gary Richardson, Federal Reserve Bank of Richmond, 22/11/2013.
x Source: FactSet, as of 12/12/2023. Eurozone Harmonised Index of Consumer Prices and US Consumer Price Index. Recession statement based on World GDP growth, 2007 – 2009.
xi Source: FactSet, as of 12/12/2023. Eurozone Harmonised Index of Consumer Prices.
xii Source: FactSet, as of 13/12/2023. Statement based on S&P 500 Index (total return) and MSCI EMU Index (total return with net dividends), in local currency, 16/7/2007 – 9/3/2009 and 12/2/2020 – 23/3/2020.
xiii Source: FactSet, as of 12/12/2023. Statement based on Eurozone Harmonised Index of Consumer Prices, November 2023 and December 2019 levels.
xiv Source: FactSet, as of 12/12/2023. Statement based on US Consumer Price Index, November 2023 and December 2019 levels.
xv Source: FactSet, as of 14/12/2023. Statement based on Eurozone Harmonised Index of Consumer Prices and US Consumer Price Index, December 2020 – November 2023.
xvi Source: FactSet, as of 12/12/2023. MSCI EMU Index constituents’ gross profit margins, 30/9/2023.
xvii Source: FactSet, as of 12/12/2023. S&P 500 Index constituents’ gross profit margins, 30/9/2023.
xviii Source: Eurostat and FactSet, as of 12/12/2023.
xix Source: Federal Reserve Bank of Atlanta and FactSet, as of 12/12/2023.