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

Last week’s market share was another example of a push and pull between stocks, bonds and the Federal Reserve, which investors should expect to see more of throughout 2021. In fact, there is reason to believe that the battle over bond yields and stock-capped inflation may not peak until summer.

The Dow Jones industrial average hit a new record last week – and the Dow future was strong on Sunday – as some sectors favored a rotation of earnings growth, including financial and industrial, and garnered additional support from the new round of federal stimulus, while the latest inflation number came below estimates. Nasdaq suddenly came back and beat, big success stories from 2020, such as Tesla. But investors looking for a completely clear signal have not received one, as the technology sold out to end the week, with 10-year Treasury bond yields hitting a one-year high on Friday.

This week’s Fed meeting on Tuesday and Wednesday could lead to action on yields and growth stocks, but with Fed Chairman Jerome Powell expected to maintain his dovish stance, some bond and stock market experts look a little further , towards the May-July period, as a key for investors. An important data point informs this perspective: inflation is expected to reach a one-year high in May and will mark a dramatic increase.

Year-on-year gains in the consumer price index (CPI) will peak in May at 3.7% for the main issue and 2.3% for core inflation, according to a forecast from Action Economics. It shouldn’t be a surprise. As the United States marks the one-year anniversary of the beginning of the pandemic, the May-May comparison is one that captures the stops that swept the country last spring and will now serve to boost the May inflation pattern.

But even in the conditions to come, the sharp rise in inflation in the coming months is likely to contribute to investors’ concerns that the Fed may underestimate 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 will attract inflation and higher interest rates.

There is a growing belief on Wall Street that an era of low interest rates and low inflation is coming to an end and that the sea will change.

“We’ve been through a very docile period of rates and inflation, and that’s it,” says Lew Altfest of Altfest Personal Wealth Management in New York. “The bottom line has been set, and rates will work there a long way back, and inflation will work, too, but not so dramatically.”

“Speed ​​is the biggest concern for investors,” said CFRA chief investment strategist Sam Stovall. “Naturally there will be an increase in inflation and we were pampered because it was under two percent for many years.”

The inflation rate has averaged 3.5% since 1950.

This week’s FOMC meeting will focus on investors in what is called the “points plot” – members ’perspectives on when short-term rates will rise, and this may not change significantly, even if it is not necessary for many members to change their view to move the median. But it is summer when the market will put pressure on the Fed on a higher inflation trajectory.

“It’s a pretty good bet that there’s higher inflation, higher GDP and a tightening on the horizon,” said Mike Englund, chief economist and chief economist for Action Economics. “Powell won’t want to talk about it, but this sets the table for that summer’s discussion, as inflation peaks and the Fed doesn’t give way.”

So far, Action Economics forecasts that inflation gains moderately in Q3 and Q4 and interest rates, anticipating CPI movements, hovering around the 1.50% average in Q3 and Q4. But Englund is worried.

“How bad the Fed really is,” he asked. “The Fed didn’t have to put its money where its mouth is and say rates will stay low …. Maybe the real risk is the second half of this year and a change in rhetoric.”

Some of the year-on-year comparisons of inflation, such as goods that fell last year, are to be expected.

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

But there is evidence in different commodity sectors of sustained earnings and upward pressure on residential real estate prices, which is not measured as part of core 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 June-July FOMC meeting and the six-monthly testimony of monetary policy to Congress on Capitol Hill the potentially most important moments for the Fed for the market.

If housing accessibility declines and commodity prices rise, it will be harder to tell the public that there is no problem with inflation. “It can fall on deaf ears in the summer when the Fed appears before Congress,” Englund said.

Altfest acts on housing inflation in its investment outlook. His company starts a residential real estate fund, because it is the beneficiary of an inflationary environment. “Stock volatility will continue, given the strong ups and downs, and hiding in the private market, focusing on cash returns rather than prices on a volatile stock market, is comforting for people,” he said.

History shows that as rates and inflation increase with economic activity, companies can pass on rising prices to customers. Last week, investors were pleased that they could end four consecutive days of gains together. According to Stovall, the stock market investors were also pampered by how suddenly the stocks advanced, so that, while the trajectory is even longer, the ascent angle was reduced.

“If there is a guarantee that we see only a short-term rise in inflation and rates and as we move beyond Q2, which seems drastically stronger than 2020, a guarantee in the second half would see the moderation of inflation and rates, investors he wouldn’t be worried, “he said.

But economic growth could force the Fed to raise short-term rates faster than anticipated.

“That adds to the turmoil,” Stovall said.

Altfest customers are divided between the manic “Biden bulls” who see a period like Roaring 20s before and the depressed, “Grantham bears”.

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

For bonds to be a real competitor to equities, rates must exceed 3%, and by the time the market approaches it, Altfest says any effect of the bond market on equities is diminished by the potential for growth and corporate profit prospects. . The value remains much cheaper than growth, even though those stocks and sectors have accumulated since the fourth quarter of last year, although it focuses more on overseas stocks, which will benefit from increased global economic demand and have not advanced as fast as the US market.

For many investors, there may not be enough confidence to add significantly to holdings as we approach the “sell in May and summer” summer period on Wall Street. But there will also be more money on the sidelines that could flow into stock prices relatively soon, including incentive payments to Americans who don’t need money to cover daily expenses and who could help support prices. short-term stocks, Stovall said.

The stimulus, while reaching many Americans with severe financial needs and including one of the largest anti-poverty legislative efforts in decades, has also reached many Americans with stimulus payments that have shown it on the market and savings have increased. The country’s savings rate is at its highest level since World War II, and disposable income has gained the most in 14 years, to 7%, doubling the gain in 2019. “And it was a year of the boom, ”Englund said.

The “sell in May” theory is a wrong name. According to CFRA data, the average change in the price of stocks in May-October is better than the available return on cash going back to World War II and 63% of the time gained stocks in that period. “If you have more than a 50-50 chance and the average yield is better than cash, why bear the taxable consequences of selling,” Stovall asked. “That’s why I always say it’s better to rotate than to retreat.”

And for now, the stock market has worked for investors through turnover in and out of technology, although last week’s Nasdaq earnings have suggested investors look for signs of stabilization there. The performance of the sector since the last S&P 500 correction in September 2020 shows that the best performing parts of the market were energy, the financial sector, materials and industry.

“Exactly those sectors that do best in a steep yield curve environment,” Stovall said. “As the Fed continues to step up its interest rates, these are the sectors that are doing well.”

Investors who have already counted this market have proven to be wrong, and investors rarely like to give up a trend that works. Therefore, Stovall’s view remains “rotating rather than retreating,” and more money in and out of growth, as investors in the stock market continue to stay with companies working in an environment of steep yield curve.

He also indicated a technical factor to follow before the summer. On average, there is a 283-day period between S&P 500 declines of 5% or more back in World War II. Since last week, 190 days have passed, which means that the market is not “really due” for another 90 days – or in other words, the beginning of summer.

Until the summer, anecdotal evidence of prices will work against the Fed. A faster pace of recovery abroad, such as in the European economy that has lagged behind the US, could also accelerate global demand and commodity markets.

For both inflation and the stock market outlook, investors face a similar problem in the coming months: “You never know you’re at the top until you start the downtrend,” Englund said.