Why the market’s manic move on the Fed is moving, inflation can only peak until the summer

Last week’s market action was another example of a push and pull between equities, bonds and the Federal Reserve that investors would expect to see more during 2021. In fact, there is reason to believe that the battle over bond yields and inflation that has gripped the stock, investors believe can only peak in the summer.

The Dow Jones industrial average set another new record last week – and the Dow’s future was strong on Sunday – as some of the sectors preferred to move away from the growth achieved, including financial and industrial, and received further support through the new round federal stimulus. , while the latest inflation figure is estimated below. The Nasdaq has hit back and forth sharply, big 2020 success stories like Tesla. But investors looking for a clear signal to sound did not get it, as technology was sold to end the week with the ten-year yield on Treasury bonds peaking on Friday.

The Fed meeting on Tuesday and Wednesday of this week may drive returns in yields and growth stocks, but because Fed Chairman Jerome Powell is expected to maintain his position, some bond and stock market experts are looking a little further May-July period, as an important one for investors. An important data point informs the view: inflation is expected to peak in one year in May, and it will be a dramatic rise.

Year-on-year gains in the Consumer Price Index (CPI) will peak in May at 3.7% for the prime and 2.3% for core inflation, according to a forecast by Action Economics. This should come as no surprise. As the US celebrates its one-year anniversary of the start of the pandemic, it is the May-May comparison that captures the closures that plagued the country last year and will now increase May’s inflationary pressures.

But even if it does, the sharp rise in inflation over the coming months is likely to contribute to investors’ concerns that the Fed may still underestimate upward inflation risks. It is only a matter of time before the economy is fully opened and economic expansion takes place at a rate that will drag inflation and interest rates higher.

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 a sea change is coming.

“We’ve been through a very easy period in rates and inflation, and it’s over,” said Lew Altfest of Altfest Personal Wealth Management, New York City. “The bottom is set and the rates are going to work there, and inflation will work too, but not as dramatically.”

“This is the speed that is causing investors the greatest concern,” according to CFRA chief investment strategist Sam Stovall. “Obviously there is going to be an increase in inflation and we are spoiled because it has been below two percent for years.”

The inflation rate has averaged 3.5% since 1950.

This week’s FOMC meeting will focus investors on the so-called ‘dot plot’ – members’ prospects of when short-term rates will rise, which may not change significantly, although many members do not need to view to move the median. But this is the summer on which the market will push the Fed to a higher inflation trajectory.

“It’s pretty good that there’s higher inflation, higher GDP and tightening on the horizon,” said Mike Englund, chief executive officer and chief economist at Action Economics. “Powell does not want to talk about it, but it sets the table for the summer discussion as inflation peaks and the Fed does not give ground.”

From now on, Action Economics predicts that inflation in Q3 and Q4 will rise moderately and interest rates, in anticipation of CPI movements, will move around the average of 1.50% in Q3 and Q4. But Englund is worried.

“How dovish is the Fed really,” he asked. “The Fed does not yet have to put its money where its mouth is and says rates will remain low. …. Maybe the perhaps real risk is the second half of this year and a shift in rhetoric.”

Some of the year-on-year comparisons in inflation figures, such as the commodities that declined last year, are to be expected.

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

However, there is evidence in various commodity sectors of sustained gains and upward price pressures in residential real estate, which are not measured as part of core inflation but an economic effect of inflationary conditions. There is currently a record low stock of existing homes for sale.

It is inflationary pressures that make the June and July FOMC meeting and the biennial monetary policy testimony to Congress on Capitol Hill the potentially more consequential Fed moments for the market.

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

Altfest acts on the inflation of housing in its investment outlook. His firm is starting a residential real estate fund because it is an inflationary environment. “Stock volatility will continue, given the strong pluses and minuses, and hiding in the private market, focusing on cash returns and not prices in a volatile stock market, is a comfort to people,” he said.

History shows that as rates and inflation increase with economic activity, businesses can pass on price increases to customers. Last week, investors were delighted to be able to pull together four consecutive days of profits. But according to Stovall, stock market investors have also been spoiled by how sharply equities have progressed, and although the trajectory is still higher, the angle of the rise has been reduced.

“If there was a guarantee that we’re just seeing an increase in inflation and rates, and if we move past the second quarter, which looks drastically stronger than 2020, a guarantee in the second half will see moderation in inflation and rates. “Investors will not worry,” he said.

But economic growth could force the Fed’s hand to raise short-term rates faster than expected.

“It contributes to the agita,” Stovall said.

Altfest customers are divided between the manic ‘Biden bulls’ ahead of a period like the roaring 20s, and the depressed ‘Grantham bears’.

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

For securities to be a real competitor to equities, rates must be more than 3%, and until the market is close, Altfest says the effect of the securities market on equities is dwarfed by economic growth potential and the prospects for corporate profits. Value remains much cheaper than growth, even though equities and sectors have risen since the fourth quarter of last year, although it is focusing more on overseas equities that will benefit from rising global economic demand and not as fast as the US market is advancing do not have.

For many investors, there may not be enough confidence to contribute significantly to the investments as we get closer to the “sell in May and go away” era in Wall Street. But there will also be more money from the sidelines that could flow into stock prices relatively soon, including from the stimulus payments to Americans who do not need the money to cover everyday expenses, and which can help drive stock prices down in the short term strengthened, Stovall said. .

The stimulus, although it has reached many Americans with serious financial needs, and one of the largest legislative efforts against poverty in decades, has also reached many Americans with stimulus payments that have plowed it into the market and increased savings. The country’s savings rate is at its highest level since World War II, and disposable income has seen its biggest gain in 14 years, at 7%, doubling 2019 profits. “And it was a training year,” Englund said.

The theory ‘sold in May’ is a misnomer. According to CFRA data, the average price change in equities during the May to October period is better than the return available from cash going back to World War II, and 63% of the time equities gained during the period. “If you have a chance of more than 50-50 and the average return is better than cash, why have taxable consequences by selling,” Stovall asked. “That’s why I always say you’re better off turning around than pulling back.”

And for now, the stock market for investors is working through the conversion into value and technology, although Nasdaq gains last week suggested that investors should pay attention to signs of stabilization there. Sector performance since the last S&P 500 correction in September 2020 shows that the best parts of the market were energy, finance, materials and industry.

“Exactly the sectors that are performing best in a weakening rate of return environment,” Stovall said. “As the Fed continues to dig so as not to raise rates, it is the sectors that are doing well.”

Investors who have already counted out this market have been proven wrong, and investors rarely want to give up a trend that works. Therefore, Stovall’s view remains ‘turning rather than pulling back’, and more money in value and outgrowth, as stock market investors continue to stay with the companies operating in a rising rate of return environment.

He also pointed to one technical factor to keep an eye on before the summer. On average, there are 283 days between S&P 500 declines of 5% or more back to World War II. Since last week, it has been 190 days, which means that the market still does not really have 90 days to go – or in other words, the beginning of summer.

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

In terms of inflation and the stock outlook, investors have a similar problem in the coming months: ‘You never know you’m on top before you tend to have a downturn,’ Englund said.