US inflation slowed less than expected in January to 6.4% from 6.5% in December last year. The reported monthly rise in consumer prices was largely expected, as gasoline prices were higher in January, pushing up overall energy prices. At the same time, rental prices continued to rise, further decoupling from the alternative measure of rental price inflation, which has been pointing to falling rents for some months. Disinflation of goods prices also slowed in January, contributing to the pause in the decline in inflation that began in June last year.

What about investor consensus?

The investor consensus has moved towards seeing bad things happening again. After dropping to below 3.4% earlier this month, US 10-year Treasury yields are flirting with 3.8% again. In our view, this could turn out to be a classic ‘sell the rumour, buy the fact’ for bond markets. In this case, after the rise in yields, we may soon witness a reversal, as the one-off items will unlikely derail a well-established trend in US inflation – and the direction of this trend is down.

We do not view such hiccups as game changers but rather as a test of investor confidence in recent trends. The same holds true for Japan, although there the trend is the other way round. Whereas yields have peaked in many other economies, Japanese yields are facing upward pressure. In the bigger scheme of things, this may be seen as an upward move that will more closely align the Japanese financial market landscape with the rest of the world. While still uncertain, the consequences of such a move would be groundbreaking.

Investors should ignore the short-term hiccups in the inflation saga and keep on hunting for bargains. The best hedge against potential tectonic shifts in Japanese rates is to buy Japanese banks, which have been implicitly taxed by zero-interest-rate policies for decades. A return to sustainably positive rates would be the start of a major payback.

Equities: On the earnings season and rotations

The Q4 earnings season in the US is moving to the late stage, with roughly 76% of the S&P 500’s market cap having reported results. On an aggregate basis, companies are slightly beating earnings estimates by +0.6% compared to consensus expectations. Defensive sectors such as healthcare and utilities show the highest upside surprises, while cyclicals such as communications and oil & gas are reporting the lowest beat ratio.

As in previous quarters, management guidance was rather cautious, with 2.5x more companies guiding lower for this year compared to those that raised guidance. However, during the earnings calls, many executives have pointed towards a weaker macroeconomic environment in the first half of 2023, with most of them already expecting a recovery as early as in H2. This view is also reflected in current consensus estimates, which point to a temporary blip in earnings and profit margins for the S&P 500, followed by a recovery in Q3 2023.

We believe the anticipation of a recovery explains the positive market reaction following the results. In contrast to previous quarters, this time around earnings misses are being bought by investors. The average price reaction after the earnings release of companies that miss on earnings is +0.8% (five-year average: - 2.2%), sending out a strong signal that the earnings risks are largely priced in by now.

As many investors seem to look through the temporary slowdown, the cyclical parts of the equity market have staged a strong comeback over the past months, particularly in Europe, which is managing to avoid a recession. That said, at current levels, the relative performance of European cyclicals vs defensives is already pricing in a strong rebound in economic activity, in line with a pickup in PMI (Purchasing Managers’ Index) new orders to 68. The valuation discount vs defensives has also evaporated by now.

We thus expect a consolidation in the relative performance at current levels and wait for a better entry point towards the middle of the year.