Although global equity markets fell in May after a strong start to the year, global macroeconomic growth remains resilient. But keeping inflation under control will be essential to avoid any unwanted surprises.

For this benign environment to continue, inflation is the key issue. That’s because any rise in inflation would likely trigger monetary policy change.

Low inflation has helped keep growth stable. This, in turn has allowed companies to expand margins, while providing central banks with more time to maintain an accommodative monetary strategy, ultimately driving higher price-to-earnings (P/E) multiples. So a return of inflation would put pressure on margins, while interest rates would begin to rise and P/E multiples would probably fall.

Sources of Potential Inflation

Several issues could prompt higher inflation. Concerns include US wage inflation, rising oil prices globally, the impact of a rising US dollar in emerging markets and continuing uncertainty over trade wars.

In the US, the April unemployment rate of 3.6% is near lows reached in the late 1990s. On top of a tight labor market, cities such as New York, San Francisco and Seattle are increasing minimum wages to $15 an hour. Major employers including Amazon, Target and Costco are raising minimum wages, too. These trends have driven wage inflation above 3%, where it has been for most of the last year.

But other trends are offsetting US wage pressures. For example, productivity is improving and more people are entering the workforce. Labor-force participation, at 63%, is around the average of the past 70 years. We believe a sustained increase in productivity amid an increase in people reentering the workforce could help suppress future wage inflation.

Oil and the Dollar

Oil prices are another focal point. The pickup in oil prices since the beginning of the year is not unexpected, given solid global growth and relatively stable supply. However, after the US administration signaled that it may tighten enforcement of sanctions on Iran, mounting concerns over constrained supply further pushed up prices in April. If the market stabilizes around this new level, oil prices would have a modest inflationary impact but probably not high enough to force a reaction from central banks.

Meanwhile, the strengthening US dollar warrants attention. For non-US economies—and especially some emerging markets—a stronger dollar exacerbates higher commodity prices. Still, at current levels, we think the dollar is trading within a manageable range.

Trade wars are the final factor potentially impacting inflation as increased tariffs would push up prices. So far, the impact has been fairly muted, with companies initially taking the hit to margins rather than passing the increased costs on to consumers. However, concerns are growing after new US tariffs on China were launched in early May. We still think a trade deal will be reached in the coming months, but failure to get a deal would be negative for global growth and inflation.

Navigating Inflationary Obstacles in Portfolios

Putting these factors together, we’re concerned that the market is underestimating the risk of inflation. If correct, that could mean faster nominal economic growth but also some pressure on P/E multiples.

Given these uncertainties, we believe companies that are “labour light” and those with strong pricing power will be better positioned to navigate the inflationary obstacles, or example companies such as Mastercard and Microsoft. Investors should certainly keep their finger on the pulse of inflation as the year unfolds.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.

AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.

Source: AllianceBernstein

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