Deflation rather than inflation could be the biggest surprise for Wall Street over the next year.
Inflation has been cooling since June, and Fundstrat’s Tom Lee noted that 59% of CPI components are now in deflation mode.
“Many of the major headwinds are leaving, opening the door for much lower prices,” Carson Group’s Ryan Detrick told Insider.
‘Big Short’ investor Michael Burry, Cathie Wood, and Paul Krugman aren’t stressing about inflation. Here’s why 5 elite market-watchers expect prices to rise slower or even fall.
Some leading market commentators aren’t fretting about inflation anymore.
They expect prices to rise more slowly later this year, and view deflation as a possibility.
Here’s what Michael Burry, Cathie Wood, Paul Krugman, Jeremy Siegel, and Tom Lee have said.
Several top-flight investors and commentators were sounding the alarm on high, prolonged inflation only a few weeks ago. Now, some elite market-watchers are predicting prices will rise more slowly in the coming months, and deflation could become the bigger risk.
Michael Burry, Cathie Wood, Paul Krugman, Jeremy Siegel, and Tom Lee have all weighed in on the fading inflation threat in recent days. Here’s a roundup of their comments:
Michael Burry
Michael Burry expects American consumers to virtually exhaust their savings by the end of this year, as they continue to save less and borrow more to cover higher food, fuel, and housing costs.
The investor of “The Big Short” fame predicts consumer spending will decline as a result, while retailers will slash prices to get rid of their bloated inventories, slowing inflation in the coming months.
“Deflationary pulses from this- -> disinflation in CPI later this year –> Fed reverses itself on rates and QT –> Cycles,” he tweeted, suggesting the Fed might cut rates and ramp up its bond purchases again once the inflation threat fades.
However, the Scion Asset Management boss also suggested that shortages of blue-collar workers, and the surge in onshoring among US companies, could lead to higher long-term inflation.
Cathie Wood
“Inflation has been a bigger problem but I think it has set us up for deflation,” Cathie Wood said in a recent CNBC interview.
The Ark Invest chief noted that chronic supply-chain issues, and Russia’s ongoing invasion of Ukraine, have fostered higher inflation this year.
However, she asserted that even elite retailers such as Walmart and Target are struggling to get rid of excess inventory, raising the prospect of widespread price cuts and deflation in the coming months.
Wood added that consumer sentiment has plunged to record lows, in part because Americans are bristling at painful inflation. She suggested that trend could also pull down prices.
Paul Krugman
Paul Krugman dismissed the idea that inflation is spiraling out of control in a Twitter thread this week.
The economist and columnist, who won the Nobel Prize for economics in 2008, pointed to Treasury-bond data suggesting investors aren’t expecting inflation to remain elevated for long.
“Not sure people realize how dramatically the runaway inflation narrative has now collapsed,” he tweeted, citing top investor Bill Ackman’s recent warnings about out-of-control inflation and unanchored inflation expectations.
Krugman added that upcoming inflation data for June might not show that expectations have declined, as retail gas prices didn’t peak until mid-June, and are yet to match the recent decline in wholesale prices.
Jeremy Siegel
Jeremy Siegel warned inflation may have peaked, and the Fed might be going overboard with its interest-rate cuts and balance-sheet reductions, in a recent CNBC interview.
The Wharton professor noted that prices of commodities and housing have dropped in recent weeks, suggesting inflation is waning. However, he emphasized that it will take time for slowing inflation to be fully reflected in official data.
“The Fed has to be careful not to slam on the brakes and just crash this economy,” Siegel said. “They have to realize most of the inflation now is behind us, even though it’s going to go through the official statistics for the next six to 12 months.”
Tom Lee
Tom Lee, the research boss of Fundstrat Global Advisors, suggested the inflation threat is receding in a note to clients this week.
Lee highlighted the recent price declines for oil, lumber, cotton, copper, and other commodities. He alo noted that a jump in mortgage rates has pushed down house prices, while a glut of retail inventory has led to large discounts for apparel, appliances, and other goods.
“Can inflation accelerate if inflation expectations and inflation leading indicators are tanking?” Lee questioned. “If a ‘disinflation’ trend is underway now, this argues inflation was indeed ‘transitory.'”
6/6 SLIDES
Wall Street has turned a blind eye to the potential for deflation in 2023, but falling prices could end up being one of the biggest surprises to investors this year.
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A review of more than 500 Wall Street outlook notes for 2023 showed not one mention of the word “deflation,” while words like “inflation” and “recession” were mentioned 807 and 853 times, respectively.
“The truth is virtually no one is expecting deflation, but this time 18 months ago no one was looking for 9% inflation either,” Carson Group’s chief market strategist Ryan Detrick told Insider.
Prices for various commodities and goods are starting to fall from their 2022 peaks, and several economic indicators suggest the declines could pickup some steam.
For example, the US Purchasing Managers Index dropped below 50 in November and December, representing a contraction in the manufacturing sector that signals lower prices to stimulate demand are likely.
Another indicator is the year-over-year change in money supply, as measured by M2. Annual M2 money supply growth has seen its biggest decline since World War II, acting as a liquidity suck for markets and the economy as well as a deflationary force.
And according to Fundstrat’s Tom Lee, 59% of CPI components were in deflation mode in December. “Disinflation (aka ‘deflation’) is accelerating,” Lee said in a Friday note, pointing out that “the pace of items ‘deflating’ is also well above the long-term average.”
Some of those CPI components include oil, which has dropped 38% from its 2022 peak, as well as new and used car prices. Meanwhile, lumber prices have dropped 67% from their 2022 peak, and the median US existing home price is 10% off its peak.
With much of the world focused on reining in inflation, it’s hard to imagine prices falling so far and so fast that actual deflation registers on the CPI this year. That hasn’t happened on an annual basis since 2009, and it’s unlikely to happen in 2023 given how entrenched inflation was throughout 2021 and 2022.
But that doesn’t mean investors should ignore the possibility that deflation will show up sooner than expected.
“It is time to utter the ‘D’ word in polite circles. Apparently, that is decidedly contrarian, for reasons of recency bias, I presume. I can’t speak for 2024, but as far as 2023 is concerned, we could very well be in for surprise CPI deflation,” WisdomTree’s head of equities Jeff Weniger said.
Falling prices are also on Detrick’s mind for 2023, as he expects inflation to fall quicker than the market expects.
“Although we don’t expect to see outright deflation, we are in the camp that inflation will come down quite quickly in 2023. We’d prefer to call it disinflation over deflation, but either way the truth is the patient has had a lot of medicine and now that China is reopening and supply chains are opening back up, many of the major headwinds are leaving, opening the door for much lower prices,” Detrick said.
As to how the stock market would react, deflation is a double-edged sword for investors. Lower prices would be a boon to consumers who have pocketed considerable wage increases recently. And some deflation would allow the Fed to end its interest rate hiking policy or even consider cutting interest rates, which would lift long-duration assets like technology stocks.
But too much deflation is arguably worse than too much inflation, as it could lead to a sharp economic slowdown, big job losses, and a surge in credit defaults if asset values drop. Ultimately, it’s a delicate balancing act.
