Why the market maniac is moving to the Fed, inflation may not peak until the summer

Last week’s market action was another example of a pull between equities, 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 yields and bond inflation that has taken stock is likely that investors will not reach their peak until the summer.

The Dow Jones Industrial Average hit another record last week – and Dow futures were strong on Sunday – as some sectors favored a rotation out of earnings growth, including financial and industrial, and gained more support. of the new round of federal stimulus, while the latest inflation number appeared below estimates. The Nasdaq rebounded sharply and surpassed the big 2020 success stories like Tesla. But investors looking for a totally clear signal didn’t get any, as the technology was sold to end the week with 10-year Treasury bond yields hitting a one-year high on Friday.

The Fed meeting on Tuesday and Wednesday this week may boost yields and growth stocks, but with Fed Chairman Jerome Powell keeping his stance obscure, some stock market experts and bonds are looking a little more towards the May-July period, as key for investors. An important data point informs this view: inflation is expected to reach a one-year high in May and mark a dramatic increase.

Year-on-year gains in the consumer price index (CPI) will peak in May at 3.7% for the main number and 2.3% for core inflation, according to a forecast by Action Economics. This should come as no surprise. As the United States turns one year since the start of the pandemic, it is the May-May comparison that captures the stoppages that took over the country last spring and will now serve to magnify inflation this month. of May.

But even seeing this, the sharp rise in inflation in the coming months is likely to add to investors ’concerns that the Fed may be underestimating the risks of rising inflation. It is only a matter of time before the economy opens up completely and economic expansion takes place at a rate that will drag inflation and interest rates to a higher level.

On Wall Street, it is increasingly believed that an era of low interest rates and low inflation is coming to an end and that maritime change is approaching.

“We’ve been through a very docile period of rates and inflation and that’s over,” says Lew Altfest, of New York City-based Altfest Personal Wealth Management. “The fund has been set and rates will work far back and inflation will also work, but not dramatically.”

“It’s the speed that worries investors the most,” according to CFRA chief investment strategist Sam Stovall. “Naturally there will be an increase in inflation and we have broken down because it has been below two per cent for many years.”

The inflation rate has averaged 3.5% since 1950.

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

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

At present, Action Economics expects inflation to gain moderately in Q3 and Q4 and interest rates, anticipating CPI movements, around 1.50% on average in Q3 and Q4 . But Englund is worried.

“How truly realistic the Fed is,” he asked. “The Fed has not yet had to put its money in its mouth and say rates will remain low … Maybe the real risk might be the second half of this year and a change in rhetoric.”

We have to wait for some of the year-on-year comparisons of inflation, such as commodities that fell last year.

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

But there is evidence in several commodity sectors of sustained gains 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 low historical supply of homes for sale.

It is inflationary pressures that make the June-July FOMC meeting and the biannual testimony of monetary policy in Congress on Capitol Hill the potentially most consistent Fed moments for the market.

If the affordability of housing goes down and commodity prices go up, 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 attends Congress,” Englund said.

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

History shows that as rates and inflation increase with economic activity, firms can pass on price increases to customers. Last week, investors were pleased to be able to put together four consecutive days of gains. But, in Stovall’s view, stock market investors have also been affected by the way stocks have advanced, so that while the trajectory is even higher, the angle of rise has narrowed.

“If there was a guarantee that we would only see a short-term rise in inflation and rates and as we move from the second quarter, which looks drastically stronger than in 2020, a second-half guarantee would see inflation moderate and rates, investors wouldn’t be worried, ”he said.

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

“That adds to the agitation,” Stovall said.

Altfest customers are divided between the manic “bulls of Biden” who see ahead a period like the Roaring 20 and the depressive, the “bones of Grantham”.

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

For bonds to be a real competitor to equities, rates must exceed 3% and, until the market approaches, Altfest says any effect of the bond market on equities is diminished by the potential for economic growth and the prospects for corporate profits. Value is still much cheaper than growth, even as these stocks and sectors have been concentrated since the fourth quarter of last year, although it focuses more on overseas stocks that will benefit from the ‘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 Wall Street sale period in the summer of “sell in May and leave”. But there will also be more cash that could reach stock prices relatively soon, including stimulus payments to Americans who don’t need money to cover daily expenses, and that could help boost stock prices to short term, 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 brought it to market. and have increased savings. The savings rate in the country is at its highest level since World War II and disposable income has experienced its biggest gain in 14 years, at 7%, doubling the 2019 earnings. “And it was a year on the rise, ”Englund said.

The “sell in May” theory is incorrect. According to CFRA data, the average change in stock prices during the period from May to October is better than the available return on cash dating back to World War II, and 63% of the time has been gained during this period. “If you have a chance above 50-50 and the average return is better than cash, why incur taxable consequences by selling,” Stovall asked. “That’s why I always say it’s better to turn around than to retire.”

And so far, the stock market has been working for investors by turning in value and out of technology, although last week’s Nasdaq earnings suggested investors see signs of stabilization there. The performance of the sector since the last correction of the S&P 500 in September 2020 shows that the parts of the market with the best performance have been energy, finance, materials and industry.

“Exactly those sectors that work best in a strong performance curve environment,” Stovall said. “As the Fed continues to dig deeper into not raising rates, these are the sectors that are doing well.”

Investors who already counted on this market proved to be wrong and investors rarely like to give up a trend that works. That’s why Stovall’s view remains to “turn around rather than retire,” and make more money in value and out of growth as stock investors continue to keep up with companies working in a curve environment. of steep performance.

He also pointed out a technical factor to consider before the summer. On average, there is a 283-day period between S&P 500 declines of 5% or more dating back to World War II. Last week, 190 days have passed, meaning the market should not be beaten for another 90 days, or in other words, at the beginning of summer.

In the summer, anecdotal pricing tests will run against the Fed. A faster pace of recovery abroad, such as in the European economy that has lagged behind the United States, could also accelerate global demand and commodity markets.

For both inflation and the stock outlook, investors are facing a similar problem in the coming months: “You never know it’s on top until the downtrend starts,” Englund said.