Morgan Stanley: disinflation will be replaced by deflation

Deflation could be a bottleneck for stocks, according to Morgan Stanley (NYSE:MS) analyst Mike Wilson, which he believes is due to the fact that falling stock prices deprive firms of pricing opportunities and reduce margins, writes Business Insider.

Mike Wilson believes that deflation will be a major drag on corporate earnings and could negatively impact share prices.

Deflation in the form of lower consumer and producer prices, which, however, gives more hope to investors for a "soft landing" of the US economy, is positively perceived by the market.

In June, the U.S. consumer price index rose 3% year-on-year, down sharply from 9.1% last summer, while producer prices rose just 0.1% year-on-year from 0.9% in June 2022. All this raises hopes for an early end to the Fed's rate hike or even its reduction.

However, the effect of the Fed's monetary tightening will take at least 12 months to fully manifest itself in the real economy, which could mean that inflation cools much faster than expected. The result could be not just disinflation, when prices rise at a slower rate, but outright deflation, when prices fall.

This would be bad news for the stock market, as companies have shown earnings growth this year amid high inflation, shifting the burden of costs onto their customers. Deflation will deprive companies of pricing power and reduce their future earnings.