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24 Jun 2022 - Hedge Clippings |24 June 2022



Hedge Clippings | Friday, 24 June 2022

Last week's Hedge Clippings noted that central bankers were caught between a rock and a hard place, trying to manage inflation by tightening monetary policy, and at the same time managing a balancing act trying to prevent their economies falling into a recession.

This week Australia's media only seemed to have a single topic (leaving aside Lisa Wilkinson's Logies stupidity) - namely inflation and wages. (No doubt the pedants will correctly note that's two topics, but they sort of go hand in hand.)

The trouble with trying to curb inflation is that it's like trying to put a smell back in the bottle - once it's out, it's out. (Only genies and little ships go back in the bottle.) There was a chance, ever so slight, that whilst inflation was "transient" or external, it might have been possible to argue it was temporary. However, once the central banks started to lift rates, it was out. The combination of higher mortgage repayments and inflation leads to wage pressure, with the inevitable risk of an interest rate/wage/price spiral, and so it goes on. And on.

Meanwhile Putin put a spike in the spokes, energy markets went into a spin, lettuces got into the act, and the price side of the spiral was confirmed.

The Prime Minister had no option but to follow through on his election promise to push for the minimum wage to rise by the then inflation rate, and the Fair Work Commission obliged by lifting it by 5.2% for 184,000 lowest paid workers, and by 4.6% for another 2.6 million workers on higher awards. RBA governor Dr. Philip Lowe said he expected inflation to peak at 7% by the end of the year, and then "moderate", and while he doesn't believe official interest rates will reach 4%, he does admit his forecasting record in that regard hasn't been spectacular, to say the least. As far as forecasting a recession, he did at least cover himself by saying while he "doesn't see one on the horizon ... you can't rule anything out."

To make his job easier, Dr. Lowe wants wages growth to be kept at 3.5%, while the ACTU's Sally McManus, not surprisingly wants her members to push for wage rises in line with inflation, which based on the RBA's forecast, means 7%, and predictably saying company profits are the cause of inflation.

None of this is unique to Australia. In fact, if anything the issue is greater in the UK, where consumer (CPI) inflation is 9.1% - the highest in 40 years, and expected to rise further. More importantly, the UK's PPI (Producer Price Index) rate is over 15%, some, most, or all of which will, sooner or later, feed through from producers to consumers.  

US Federal Reserve Chair Jerome Powell was even blunter than Philip Lowe - or maybe more realistic depending on one's view, acknowledging that a recession in the US was certainly a possibility. At the same time he reiterated that two key factors driving inflation - namely, energy prices and supply chain constraints - were out of his control, and that if he had to raise rates by 1% to curb inflation at the next or future meetings, he would.

Against this backdrop it is no wonder that markets have rotated from last year's risk on, to this year's risk off, with the basis for equity valuations and multiples finally switching from forecast revenue, (or even consumer or subscriber numbers) to earnings, and then to recurring earnings in particular. In the upcoming reporting season there will no doubt be further revisions to equity prices as investors' and analysts' focus switches to recurring profit, or ROE.

As the P side of the P/E ratio falls, so value - and buyers - will no doubt return.

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