Alleviating Inflation Fears
Contributed by Doug Walters, Max Berkovich, David Lemire
Inflation is top of mind these days. It is hard to watch the news or read the paper without hearing commentary about rising prices. The nature of the stories has a tendency to add angst as the headlines are fantastic: “The Highest Inflation in Nearly Four Decades!” So, while we will add to the inflation commentary with this issue of Insights, we hope to alleviate some of that unease.
This week’s 7.0% CPI print put inflation top of mind again (or perhaps it was already there?). There is no question these are big numbers. The Fed has ramped up its commentary about “tapering” and “liftoff” with the implication that they will get more aggressive combating inflation as necessary. It is the Fed commentary, more than inflation itself, that has investors on edge.
So what is wrong with the Fed fighting inflation? Nothing. It is exactly what they should be doing. However, regardless of right or wrong, if fighting inflation requires raising rates, it has the potential to hit stock valuations. That is part of the reason you will hear investors say, “Don’t fight the Fed.” If inflation is stubborn, the Fed could be forced to raise rates to the point that they are pumping the brakes on the economy. Again, not a great scenario for investors.
How are we doing alleviating your angst about inflation? The reality is that the path of inflation is not predetermined. There is no reason to believe the Fed will not be able to get inflation under control without derailing economic growth. We just do not know, and investors should not waste their time worrying about the unknowable. Instead, they should spend their time ensuring they are prepared regardless of the scenario. We talked a lot about this a few weeks ago (Combating Inflation with Diversification). If you have a well-diversified portfolio, then you can rest easy that you are prepared. It does not mean your portfolio cannot go down; quite the contrary. But it does mean that you can rest easy that you should be able to enjoy the long-term benefits that investment markets offer.
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US stocks fell this week, led down by Growth stocks. Year-to-date, the Russell 1000 growth index is down around 6% compared to a slightly positive return for the value index. Hurting sentiment for growth stocks has been inflation, or more specifically, the Federal Reserve’s intent to combat inflation.
Inflated Expectations
CPI inflation was released on Wednesday. The headline 7.0% was slightly below the 7.1% expected by analysts and up from the 6.8% printed the prior month.
- 7.0% was the highest in nearly four decades.
- Core CPI (ex-Food and Energy) was up a more modest 5.5%.
- US stocks responded positively, implying that investors were bracing for worse.
Growth Challenges
Growth stocks have stumbled this year. It is not directly because of inflation, but it is related.
- The Federal Reserve has made it clear that it will be addressing inflation head-on with its policies in the coming months.
- Fed commentators were out in force this week talking about accelerated asset purchase tapering, and some were talking about “liftoff” (i.e., raising rates) sooner rather than later.
- Growth stocks, whose valuations are based on expectations for big future profits, are most sensitive to rate increases (why? because the discount rate on those future profits goes up as interest rates rise).
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