Why Falling Inflation Is a Problem for the Stock Market
Generationally high inflation was the story of 2022. That’s not going to be the story of 2023. The boogeyman of disinflation—and even some deflation—is about to become the biggest risk to stocks, and investors are going to have to figure out how to position portfolios for falling prices.
U.S. consumer prices rose 6.5% year over year in December, the sixth consecutive month the pace of pricing gains decelerated. Investors were pleased. The S&P 500SPX +0.40% gained 2.7% for the week. The Dow Jones Industrial AverageDJIA +0.33% gained 672 points, or 2%. The Nasdaq Composite COMP +0.71% was the big winner, closing up 4.8%.
Inflation, while slowing, is still here, though it might not be for much longer. Signs of looming price declines are starting to show up. Take apartments, which about 40 million Americans call home. They felt the inflationary pain in 2022, with average rents up about 7% year over year, according to the Bureau of Labor Statistics. But those high prices have started to pinch, and now it seems like no one is looking to move.
Real estate service provider RealPage notes that demand had “all but evaporated” by the end of 2022. “Volume always precedes price,” says one real estate investor, and he’s right. Rents will have to fall to get people thinking about moving again.
Car prices are also too high. The average new-car price in the U.S. hit a record $49,507 in December, according to data provider Cox Automotive. Those prices are starting to hit demand as well, and forcing companies to reconsider. Tesla TSLA –0.94% (ticker: TSLA), for one, cut prices for some of its vehicles
Price Cuts, Downgrades, the Market. Why Tesla Stock Is Having a Very Bad Day.
Certain new models of the EV company's Model 3 and Model Y vehicles are eligible for a $7,500 tax credit on new electric cars and plug-in hybrids.
Continue reading by up to 20% this past week as inventory piled up and order rates took a dive.
Everywhere we look, the price of goods is coming down. Steel? Aluminum? Copper? Oil? Corn? They’re all down 30%, on average, from the highs reached last year.
The one thing that isn’t coming down is wages, thanks to a labor market that still looks strong, with job openings in the U.S. holding steady between 10 million and 11 million. The combination of falling product prices with a strong labor market isn’t great news for investors, because companies will have to pay more for workers but will receive less for what they sell. Profit margins “are going to compress,” says Brian Rauscher, head of global portfolio strategy at Fundstrat. “That’s a given.”
Savita Subramanian, BofA Securities’ head of equity and quantitative strategy, expects the same. S&P 500 earnings estimates for 2023 are roughly 15% too high “amid demand uncertainty and a tougher pricing environment,” she writes.
She’s hunting for areas of the economy that can produce “more margin” and says healthcare stocks are a good place to look. BofA analysts favor stocks such as Boston Scientific (BSX), Intuitive Surgical (ISRG), and Tenet Healthcare THC +1.13% (THC).
Demand uncertainty is starting to show up, as well. Rauscher points out that new orders—a leading indicator of demand—are falling. The Institute for Supply Management’s index of new manufacturing orders has been in negative territory for six of the past seven months. Its index of new service orders slipped into negative territory in December for the first time since the spring of 2020.
“There is going to be a pricing power issue as we move forward…[so favor] companies with stickier margins,” says Rauscher. He wants ones that can still raise prices, cut costs effectively, or both.
That could mean trouble for the stock market overall, despite the strong start to the year. He recommends holding higher-quality companies with better balance sheets and strong management teams.
That’s a solid strategy for any market—and it’s especially wise when prices start to drop.