The dominoes that will fall once inflation peaks out

With headline inflation in the US currently sitting at 8.3%, and Australian inflation comparatively better at 5.1%, WILSONS' David Cassidy believes that there's potential for investors to start seeing signs of peaking over the next few months. 

"The peak here is going to be later, but I think the market will take its lead from what happens in the US, and we think we could be quite close to an inflation peak there. And if we are, I think central banks can relax a little bit. Markets can relax."

Read or watch below to find out how David is positioning his stocks in light of these market currents.  

Note: This interview was filmed on Thursday 12th of May, 2022. You can watch the video or read an edited transcript below. 

Key takeaways

• We could be further through the cycle than commonly thought
  
• Overweight alternatives
  
• Cost theme will play centre stage as companies report
  

Edited Transcript

Do you think central bank tightening will lead to a sustained bear market or a landing?

David Cassidy: That's the trillion dollar question, isn't it? Whether the tightening cycle is going to lead to a bear market. Our central case would be that we can still avoid a bear market. 

We think we can avoid recession over the next 12 to 18 months. There are certainly risks around that view, but we do think we'll start to see some relief on inflation as we move forward over the next few months. 

Indeed, we think there's potential for US inflation to start showing some signs of peaking and coming off the boil. Some of those very high inflation categories can actually come off and start deflating over the next few months.

So there's still a lot of push and pull around inflation. Some economies like Australia are, I think, lagging on the whole inflation cycle. The peak here is going to be later, but I think the market will take its lead from what happens in the US, and we think we could be quite close to an inflation peak there. And if we are, I think central banks can relax a little bit. Markets can relax. Ten year bond yields will probably, if not rally, certainly peak. 

And so I think there is the prospect of better conditions in the second half of the year for equities and bonds on the back of that inflation peak and possibly this idea of peak Fed and peak concern around central bank tightening.

Will peak inflation be the start of a market recovery?

I think so. I think there's been this big debate about transitory and structural in relation to inflation. 

There's an element of both happening at the moment, but there is a significant transitory component in regards to what's going on with inflation. It's clearly taking longer to come off the boil, and it's still complicated, and there is some structural inflation push happening at the same time. 

But with US inflation at 8.5% headline, I do think it'll be a lot lower 12 months from now.

The market will like that, and that will take the pressure off central banks to some extent. It doesn't mean the inflation problem is completely solved. It could come back and raise its head later in the cycle, but I think if we get some better numbers over the next three to six months. That would set up the potential for another rally in the stock market over the next six months, at least.

How have you modified the portfolio in light of inflation?

I guess we've been what are call tactically cautious through this calendar year, so broadly neutral on equities with a bias towards Australia, heavily underweight fixed interest, and where we've been overweight has been what we call alternatives, which is a catch-all phrase of things like private equity, private debt, market-neutral hedge funds, and real assets like infrastructure. So I've had quite a long position in alternatives, which has helped us.

It's been hard because both equities and bonds have been under pressure. But I do think, if we get some signs of inflation peaking, that's a better backdrop for bonds and a better backdrop for stocks. 

We are still a little bit cautious as we don't exactly know when that peak is going to be. Is it this week? Is it next week? Or next month? Markets are on a knife edge at the moment, so we are still proceeding somewhat cautiously. But we're not overly bearish about the world, at least not at this point.

What should investors be focused on as companies report?

If you look at what happened in the US, and a little bit in terms of our mini reporting season that was just unfolding at the moment in relation to the March year-end of Aussie companies, I think it's this cost theme that's really coming through. 

We finally saw evidence in the US reporting season that costs were starting to bite. It wasn't a disaster. There was still good top line growth, and overall the US reporting season was okay, but it was a lot more mixed.

And I think even with the mini Aussie reporting season that's unfolding right now, you have seen some cost pressures come through in the banks in particular. I think that's going to be a broader theme for the corporate sector, both into the June confession season and into the August results. It's that cost line we've got to watch pretty closely. It's a hard one to predict, but that's going to be the focus.

The top lines are generally going to be okay, but we'll see in terms of outlook statements, whether this concern around interest rates and consumer sentiment is starting the bite already. It's a bit early for that. 

Is pricing power king? 

I think so. If companies have got the ability to pass it on, that's obviously good for margins. When a company just can't pass through that pressure, that's going to be obviously a big red flag. As I said, inflation will peak, but particularly in terms of Australia, we're a fair way from that relief. So it's going to be a theme through this year at least and possibly into next year in respect of the Australian corporate scene.

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