Will inflation lead to recession?
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1: Stock valuations are stretched
Stock valuations are excessively high in many respects. This first chart compares stocks relative to bonds, in terms of performance. It shows that the current relative outperformance of stocks is very unusual.
However, I’d note this partially is a result of fairly weak absolute returns for bonds in general.
Almost 16% of S&P 500 companies have price to sales ratios over 10. This essentially means the payback period for investors is excessively long.
The driver behind these high price/sales ratios is the assumption that revenues will grow rapidly, and higher future cash flows will make up for today’s valuations. Of course, this has been the common narrative behind every bubble throughout history.
2: Inflation is creating economic risk
The chart below shows CPI (line) against economic recessions (shaded bars). Almost all recessions during the post-war period were preceded by CPI punching above 5%. As we saw in December’s retail sales data, consumers pull back spending when prices rise.
Consumer sticker shock and increasing central bank monetary policy restraint are two ingredients that could lead to a recession in a few quarters. While there are some early signs that inflationary pressures are easing, this is such a huge force right now we need to pay attention. Stay tuned…
3: Top and bottom performing commodities each year since 2012
Rising fossil fuel and agriculture prices are having a direct impact on consumer finances. Inflation will continue to be a top concern for citizens of the world.