This Thursday I attended an excellent presentation by Professor Jeremy Siegel, organized by Compass Group and WisdomTree. Siegel is a professor of finance at the Wharton School at the University of Pennsylvania and author of the famous book Stocks for the Long Run.
The focus of the class was the outlook for US inflation and the impact on interest and equity markets.
The professor illustrated in a very well-founded way why he believes that American inflation is not as fleeting as the Fed, the American Central Bank, mentioned until the end of last year.
Siegle reminds everyone about the economic theory that says that inflation can be estimated by the difference between the growth of the monetary base and the real growth of the economy.
In the chart above, he illustrates that the historical growth of the monetary base until 2020 was of the order of 5.3%. With historical economic growth between 2% and 3% a year, this resulted in annual inflation in the United States approaching 2%.
However, after 2020 this growth in the monetary base jumped to a rate of over 16% per year. With US real GDP growth currently around 4%, he believes inflation is almost inevitable.
Another graph he used to illustrate this projection follows below. Notice how inflation (red line) evolves in line with base money over the last 150 years.
He believes that this higher inflation, together with a strong growth economy, should lead the Fed to have to accelerate interest rate increases.
With this move, he believes that the American fixed income market will not be a good investment in this period of monetary tightening.
Contrary to what many imagined, he argues that for the stock market the vision is not the same.
Based on his experience in other monetary tightening movements by the Central Bank, he maintains that the stock market remains positive at the beginning of the cycle of high interest rates.
Only in the second stage of the interest rate hike cycle would the stock market react negatively, but this would only occur in 2023, in his view.
Although he suggests to the audience to reduce exposure to US fixed income and increase participation in the stock market, he believes that the performance of the stock market will be inferior to the last three years. Additionally, he warns that, in this period of high interest rates, the stock markets should show strong volatility.
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