If we see all the elements of inflation coming back towards 0 per cent and a smidgen of soft economic data, we will see people making the inevitable inference that we have achieved 'immaculate disinflation', and boost growth back into a bull market.
We have already gotten a taste of this in 2023.
The danger to jumping on this bandwagon and riding off to the races once again is that this very rosy scenario has already been priced into the market – in other words, the horse has already bolted.
This not a call for switching into a portfolio of cheap value stocks, but it is certainly a cautionary note about doubling down on the current strength of these mega-cap growth stocks.
If inflation remains sticky, central banks will want to keep rates higher for longer. This should erode the strength of this growth rally and begin degrading many businesses in the global economy that were built to survive on interest rates at sub 2 per cent – aptly coined 'zombie companies'.
The deeper risk is that, if economic weakness does come through in global economies while inflation remains stubbornly high, central bankers will face a dilemma: keep rates high to kill inflation or cut them to stimulate the economy as it slows, yet run the risk of inflation surging back like it did in the 1970s.
Make no mistake, the rally thus far has priced in a 2023 road map in which inflation slows steadily, with a little economic slowdown.
This forms a perfect scenario for central bankers to slowly cut rates and stimulate a slowing economy without running the risk of sparking inflation.
That is the playbook as it currently stands and, even as I write this, economic data is starting to pull the shine off that trade.
James Penny is chief investment officer at TAM Asset Management
