Skip to main content

Service, please! Three-minute macro

Inflation continues to be stubborn, but now we’re focused more on the services component, which is causing the bulk of the pain. Meanwhile, with volatility pretty much everywhere, investors find themselves without many assets to turn to because of rising asset class correlations. Finally, we take a look at the potential of the Brazilian equity market, which looks cheap.

Service prices continue to weigh on inflation

The September CPI print in the United States ran a cold shower over any hopes of a rapid deceleration in prices. Beyond both the headline (+0.4% month over month (MoM)) and core measures (+0.6% MoM) coming in 0.2% above expectations, the acceleration in services inflation remains a key source of worry. Core services’ contribution to total inflation has steadily grown in 2022, adding 0.5% to the headline figure in September. Within services, we note shelter costs rising at their fastest pace since 1982 (6.6% year over year). This component was boosted principally by owners’ equivalent rent (OER), which reflects past increases in home prices and higher mortgage costs. Unfortunately, this series is slow moving: OER will likely accelerate until the end of the first quarter of 2023, when the effects of lower U.S. home prices in 2022 start reflecting in the index.

Taking a step back, while we anticipate that core inflation will continue to rise over the next few months, a larger (albeit less well-known) set of price data suggests that disinflationary pressure should be reflected in consumer prices in 2023—Producer Price Index final demand (even if it rose more than expected in September), Institute for Supply Management services prices, Purchasing Managers’ Index output prices, the Zillow rent index, and the Manheim used car prices index. Moreover, on the goods side, retailers in certain areas are sitting on an uncomfortably high level of inventories resulting from the bullwhip effect of the pandemic; therefore, large discounts related to inventory clearance aren’t out of the picture going into 2023.

Lesser-known price data suggests a slowdown

Selected measures of prices since 2019

Line chart of various measures of prices, including PPI final demand, ISM services, Zillow observed rent, PMI output prices, and the Manheim used vehicle value index. It shows them moderating over the last 6 months.
Source: ISM, BLS, IHS Markit, Manheim Consulting, Macrobond, Manulife Investment Management, as of October 14, 2022. PMI refers to Purchasing Managers' Index. PPI refers to Producer Price Index. YoY refers to year over year.

Cross-asset correlations in new (and disturbing) territory

With markets continuing to trade in a tumultuous nature with elevated volatility levels and negative returns in most asset classes year to date, cross-asset correlations that have traditionally been relied on by investors are continuing to break down. Most notably, the correlation between equities and bonds (measured by the S&P 500 Index and Bloomberg U.S. Aggregate Bond Index 200-day rolling correlations) is at its highest in over 20 years. The current reading of 0.21 is miles away from the long-run average of
–0.29.

Market movements this year have been driven by reaction to unexpectedly aggressive monetary policy tightening. With each adjustment higher, most assets have rerated lower as higher peak policy rates are factored in. Conversely, when the underlying macroeconomic data has provided markets with a glimmer of hope that we might get a dovish pivot from central banks, bonds and equities have rallied together. Unfortunately for those seeking easy diversification, we expect this correlation pattern to continue as monetary policy uncertainty remains high.

Asset correlations aren't doing anyone any favours

Correlations, U.S. stocks and bonds since 2008

Line chart of correlations between U.S. stocks and bonds since 2008. It shows a correlation of 0.21, the highest in over 20 years.
Source: Bloomberg, Macrobond, Manulife Investment Management, as of October 12, 2022. U.S. stocks are measured by the S&P 500 Index. U.S. bonds are represented by the Bloomberg U.S. Aggregate Bond Index. It is not possible to invest directly in an index.

Election results bolster the case for Brazil

Brazil’s presidential election on October 1 resulted in a win (although not as convincingly as some expected) by leftist Luiz Inácio Lula da Silva against far-right Jair Bolsonaro. The tighter-than-expected results set the stage for the runoff round on October 30, but investors took comfort in this outcome: The closeness of the election may force Lula’s campaign into more of a centrist form; a centrist-tilted Lula government will likely bring clearer policy visibility and tax reform. We caution the risks around the fiscal framework but, overall, we see this development as market friendly.

We’ve been bullish on Brazilian equities. Even against the backdrop of a 40% outperformance against emerging-market equities year to date, the changing political dynamic incrementally supports our thesis. We view a Lula government as one that would improve sentiment around Brazilian assets for both foreign and domestic investors, which are trading at a discount by several measures. Brazilian equities are cheap relative to history: At 7.8x forward earnings, Brazil’s price-to-earnings ratio sits substantially below its long-run average. Brazilian assets have a policy uncertainty discount baked in that we expect to retreat after the runoff election round, which makes us comfortable with an overweight in Brazilian assets. 

Brazilian equities look cheap on a historical basis

MSCI Brazil Index and its P/E ratio

Line chart of the MSCI Brazil Index and its P/Es ratio. At 7.8, the P/E ratio is well below its historical average of 10.4.
Source: Macrobond, Manulife Investment Management, as of October 14, 2022. P/E ratio refers to price-to-earnings ratio.

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person.

All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients and prospects should seek professional advice for their particular situation. Neither Manulife Investment Management, nor any of its affiliates or representatives (collectively “Manulife Investment Management”) is providing tax, investment or legal advice.

This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.

Manulife Investment Management shall not assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here.  This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.

A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.

This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by Manulife Investment Management and its subsidiaries and affiliates, which includes the John Hancock Investment Management brand.

Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

2520864

Erica Camilleri, CFA

Erica Camilleri, CFA, 

Senior Global Macro Analyst, Multi-Asset Solutions Team

Manulife Investment Management

Read bio

Category

Tags