Why manic market movements on the Fed, inflation may not peak until summer

Last week’s market action was yet another example of the push and pull between stocks, bonds and the Federal Reserve, which investors should expect to see more of in 2021. In fact, there are reasons to believe that the battle over US earnings bonds and the inflation that dominated stocks investors may not peak until the summer.

The Dow Jones Industrial Average broke another new record last week – and Dow’s futures were strong on Sunday – with some of the favored sectors in a spin away from growth won, including financial and industrial, and gained more support from the new stimulus round. inflation, while the latest inflation figure was below estimates. Nasdaq has recovered strongly and the great success stories of 2020, like Tesla’s, have recovered. But investors looking for a clear sign of failure have failed, as the technology was sold to end the week with 10-year Treasury bond yields reaching a one-year high on Friday.

The Fed’s meeting on Tuesday and Wednesday this week may boost yield shares and growth stocks, but with Fed Chairman Jerome Powell, expected to maintain his dovish stance, some bond and stock experts are looking a little further, for May-July period, as a major for investors. An important piece of information informs this view: inflation is expected to peak at one year in May and will mark a dramatic increase.

Annual gains on the Consumer Price Index (CPI) will peak in May at 3.7% for the main figure and 2.3% for core inflation, according to a forecast by Action Economics. This should not come as a surprise. As the United States celebrates the one-year anniversary of the start of the pandemic, it is the May-May comparison that captures the strikes that affected the country last spring and will now serve to broaden the impression of this May’s inflation.

But even predicting this, the sharp rise in inflation in the coming months is likely to raise investor concerns that the Fed may still be underestimating the risks of rising inflation. It is only a matter of time before the economy is fully open and economic expansion takes place at a rate that increases inflation and interest rates.

There is a growing belief on Wall Street that an era of low interest rates and low inflation is ending and that a radical change is coming.

“We went through a very docile period in terms of rates and inflation and that is over,” said Lew Altfest of Altfest Personal Wealth Management in New York. “The bottom of the well has been established and rates will rise again and so will inflation, but not so dramatically.”

“It’s the speed that worries investors the most,” according to CFRA’s chief investment strategist, Sam Stovall. “Naturally, there will be an increase in inflation and we are spoiled because it has been below 2% for many years.”

The average inflation rate has been 3.5% since 1950.

This week’s FOMC meeting will focus investors on what is called a “plot plot” – members’ perspective on when short-term rates will increase, and which may not change to a significant degree, although many members are not required to change your views to move the median. But it is the summer when the market will put pressure on the Fed on a path of higher inflation.

“It is a very good bet that there will be higher inflation, higher GDP and a contraction on the horizon,” said Mike Englund, principal director and chief economist at Action Economics. “Powell won’t want to talk about it, but it sets the table for the summer discussion, when inflation peaks and the Fed doesn’t budge.”

As of now, Action Economics expects inflation gains to moderate in the 3rd and 4th quarters and interest rates, anticipating IPC movements, hover around the average of 1.50% in the 3rd and 4th quarters. But Englund is concerned.

“How dovish the Fed really is,” he asked. “The Fed has not yet had to put its money where its mouth is and say that rates will remain low … Perhaps the real risk is in the second half of this year and a shift in rhetoric.”

Some of the year-over-year comparisons in inflation figures, such as commodities that plummeted last year, are expected.

“We know that people will try to explain it as a comparison effect,” says Englund.

But there is evidence in several commodity sectors of sustained gains and upward pressure on home prices, which is not measured as part of the core of inflation, but is an economic ramification of inflationary conditions. There is currently a record low supply of existing homes for sale.

These are inflationary pressures that make the FOMC meeting from June to July and the semiannual testimony of monetary policy to Congress on Capitol Hill the Fed’s potentially most important moments for the market.

If the price of housing is falling and commodity prices are rising, it will be more difficult to tell the public that there is no problem of inflation. “It may fall on deaf ears in the summer, when the Fed goes to Congress,” said Englund.

Altfest is acting on real estate inflation in its investment outlook. Your company is opening a residential real estate fund because it benefits from an inflationary environment. “The volatility of stocks will continue due to the strong positives and negatives and hiding in the private market, focusing on cash returns and not prices in a volatile stock market, it is comforting for people,” he said.

History shows that, as rates and inflation increase with economic activity, companies can pass on price increases to customers. Last week, investors were pleased to be able to tie four consecutive days of earnings together. But, in Stovall’s opinion, stock market investors were also hampered by the way the stock moved forward quickly, so although the trajectory is even higher, the angle of rise has been reduced.

“If there was a guarantee that we would see only a short-term recovery in inflation and rates and as we move into the second quarter, which looks drastically stronger than 2020, a guarantee that the second half would see moderation in inflation and on rates, investors don’t worry, “he said.

But economic growth may force the Fed to raise short-term rates more quickly than anticipated.

“This is adding to the excitement,” said Stovall.

Altfest’s customers are divided between the maniacal “Biden bulls” who see a period like the crazy 1920s ahead, and the depressive, the “Grantham bears”.

He says that both can be right. Interest rates may continue to rise and, at the same time, corporate profits increase. More profits equate to a better stock market, while higher interest rates put pressure on price / earnings ratios, providing more opportunities.

For bonds to be a real competitor to shares, rates have to pass 3% and, until the market is close to that, Altfest says that any effect of the bond market on shares is overshadowed by the potential for economic growth and the corporate profit perspective. The value remains much cheaper than growth, even with these stocks and sectors recovering since the fourth quarter of last year, although it is more focused on stocks abroad that will benefit from the increase in global economic demand and have not progressed so fast. as the US market.

For many investors, there may not be enough confidence to significantly increase holdings as we approach Wall Street’s “sell in May and go” summer period. But there will also be more money on the outside that can flow into stock prices relatively soon, including stimulus payments to Americans who do not need the money to cover daily expenses, and which can help boost stock prices in the future. short term, said Stovall.

The stimulus, while it hit many Americans in dire financial need and included one of the biggest anti-poverty legislative efforts in decades, also hit many Americans with stimulus payments that put it on the market and increased savings. The country’s savings rate is at the highest level since World War II, and disposable income has experienced the biggest gain in 14 years, at 7%, doubling the gain in 2019. “And that was a year of expansion,” he said. Englund.

The “May sale” theory is a misnomer. According to CFRA data, the average change in stock prices during the period from May to October is better than the cash return available since World War II, and 63% of the shares gained during the period. “If you have a better chance than 50-50 and the average return is better than money, why incur taxable consequences when selling,” asked Stovall. “That’s why I always say that it is better to turn than to retreat.”

And for the time being, the stock market has been working for investors through turnaround in value and out of technology, although last week’s Nasdaq gains suggested that investors be on the lookout for signs of stabilization. The performance of the sector since the last correction of the S&P 500 in September 2020 shows that the best performing parts of the market were energy, finance, materials and industrials.

“Exactly the sectors that do best in an increasingly sloping yield curve,” said Stovall. “While the Fed continues to try not to raise rates, these are the sectors that do well.”

It has been proven that investors who already counted this market were wrong, and investors rarely like to give up on a trend that is working. That’s why Stovall’s vision continues to “spin instead of retreat” and more money coming into value and coming out of growth, as stock market investors continue to stay with companies that work in a curve environment. increasingly sloping yield.

He also pointed out a technical factor to be noted before the summer. On average, there is a 283-day period between declines of 5% or more in the S&P 500, since World War II. Last week, 190 days passed, which means that the market “just waits” for the next 90 days – or in other words, early summer.

In the summer, anecdotal evidence of prices will be working against the Fed. A faster pace of recovery abroad, as in the European economy, which lagged behind the US, could also accelerate global demand and commodity markets.

Both for inflation and for the stock outlook, investors face a similar problem in the coming months: “You never know you are at the top until you start the bearish trend,” said Englund.