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November 27, 2023

Chart of the Week: Equities in a disinflationary world

by Lauren Tuck.

The S&P 500 has increased by 10% in the past month amid continued signs of disinflation and the corresponding implied easier path for monetary policy. The benchmark US index is nominally 40% above its pre-COVID level and only 5% off its all-time high, set in January 2022. However, the price level has increased a lot in recent years. Adjusting for this, the picture is a little different: the ‘real’ S&P 500 is around 25% above its pre-COVID level, and still 9% off its record high.[1] High inflation has been a headwind to equity prices, as multiples narrowed amid interest rate increases. However, it has also made it easier for companies to deliver growth in nominal variables such as revenue and earnings. As the disinflationary process continues, both these factors will go in reverse. Expectations of easier monetary policy have already had a positive effect on multiples, and this could increase if rates drop below what is priced in. However, delivering 8% earnings growth is more difficult when nominal GDP is expanding at 3% rather than 7%. On balance, we see US equities doing well as the disinflationary process continues. This is because easing price pressures are continuing to reduce the odds of recession. In a ‘soft landing’ environment, the S&P 500 could rise above previous highs next year — both nominal and real.

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[1] We update the ‘real’ S&P 500 using the November 24 closing price and an implied 0.3% monthly increase in headline inflation, which is in line with its six-month average.

The views expressed in this article are the views of the author, not necessarily those of LSEG.

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