To The Moon

The resilience of the US economy is a testament to its robust fundamentals and adaptive strategies. As disinflationary currents flow, two heavyweight reports - one from Morgan Stanley and the other from Barclays - offer deep dives into its nuanced effects on earnings and sectoral dynamics.

Disinflation's Broader Brushstrokes on Earnings

Disinflation, while signaling a deceleration in price rises, casts a multifaceted shadow on corporate earnings. Morgan Stanley underscores that while disinflation can offer a reprieve from escalating costs, the lingering effects of temporary pricing power can still pose challenges. Companies that ramped up prices in an inflationary environment might find themselves cornered if consumers, sensing the disinflationary trend, anticipate price stabilization. This dynamic can lead to a squeeze in profit margins, especially if input costs remain elevated.

According to Morgan Stanley Research, sales will likely disappoint further when PPI Finished Goods is fading.

Source: Morgan Stanley

Barclays Research also expects negative operating leverage due to disinflation to be a strong headwind for S&P 500 sectors' 2023 forward EPS excluding tech sector.

Source: Barclays

However, Barclays believes tech sector $Technology Select Sector SPDR Fund(XLK)$ to stand resilient amidst these pressures. They suggest that the earnings from the tech sector might not necessarily diffuse or spread to other sectors in the S&P 500. This could be attributed to the tech sector's inherent strengths, such as innovation, which might shield it from broader market pressures.

Sector Spotlight: Navigating the Disinflationary Landscape

Technology's Triumph:

Both Morgan Stanley and Barclays nod to the tech sector's resilience. In a world increasingly pivoting to digital, tech firms have showcased an uncanny ability to weather economic tempests. Barclays particularly emphasizes tech's potential to maintain robust margins amidst cost pressures.

Source: Barclays

Consumer Conundrum:

Morgan Stanley paints a cautious picture for the consumer discretionary sector $Consumer Discretionary Select Sector SPDR Fund(XLY)$ . Disinflation might lead to consumers tightening their purse strings, anticipating better deals down the road. This cautious consumer behavior could dent the revenues of companies in this sector.

Barclays also expresses negative views on consumer discretionary with respect to valuations and expected weakness in consumer spending.

Industrial Optimism:

Barclays casts a favorable glow on the industrial sector $Industrial Select Sector SPDR Fund(XLI)$ . With moderated input costs and potential pricing power, industrials might find themselves in an enviable position, poised to enhance profit margins.

Source: Barclays

Barclays also believes industrials remain a good place to hide within cyclicals because its lagged COVID base effects driving easier YoY EPS "comps" and its low international sales exposure.

Financials' Fate:

The financial realm, especially banking, might find the disinflationary environment a tad challenging. Barclays points out that subdued interest rates, a potential offspring of disinflation, can compress the profit margins of financial entities. Barclays is skeptical of a strong rebound in financial sector EPS growth next year, as they expect current economic headwinds and tighter financial conditions to persist.

Conclusion

Disinflation, a macroeconomic phenomenon, has microeconomic ripples. Its influence spans sectors, shaping corporate strategies and investor outlooks. The insights from Morgan Stanley and Barclays, serve not just as observations but as guiding beacons, illuminating the intricate pathways of a market molded by disinflation.