Inflation Concerns Overdone
Contributed by Doug Walters, Max Berkovich
Inflation fears were top of mind for investors this week, sending stocks lower. It is amazing how quickly we have gone from concerns of a deflationary spiral to runaway inflation. This week’s instigator was a surprising Consumer Price Index (CPI) report that showed higher-than-expected year-on-year growth. The Federal Reserve played the role of placater, which appears to have paid off as the week progressed.
It was not too long ago economists were concerned that, with rates so low, the Fed had run out of tools to boost the economy and that the U.S. could be following the path of Japan. The land of the rising sun has been battling deflationary pressures for the better part of two decades. Suddenly, concerns have turned 180 degrees toward inflation. Why does inflation matter? Currently, the Fed is boosting the economy with low-interest rates and asset purchases (aka quantitative easing). Should inflation begin to run too hot, the Fed’s hand will be forced into tapering its stimulus sooner than expected. “Taper” is a dirty word for stock investors, as equity prices have historically pulled back as the Fed scales back its monetary support.
The CPI reading this week was much higher than expected, sending the market down. Interpretation is a challenge, though, thanks to two factors: 1) prices were depressed last year due to the pandemic, and 2) demand for goods and services, as reopening accelerates, is bouncing back more quickly than companies can supply. Supply chains take time to rebuild, and companies likely took a cautious approach. The Federal Reserve was out in force this week saying as much. They are sticking to their claim that this bout of inflation is transient and should not concern the U.S. economy. The stock market rewarded their persistence with a bounce Thursday and Friday.
Inflation was much higher than anticipated
Inflation, as measured by the Consumer Price Index (CPI), came in much higher than expected. The reading comes at a time when investors fear that inflation may force the Fed’s hand into a soon-than-expected reduction in stimulus.
Path to Normality
- The Centers for Disease Control and Prevention (CDC) stated that fully vaccinated individuals do not need to mask in most settings (unless required by an establishment). Following the CDC update, at least eight states lifted mask mandates.
- The U.S. COVID-19 infection rate continues to fall amid successful vaccine rollouts. Teachers’ unions are calling for reopening all schools this fall.
- Due to the measured success of the vaccine, the pandemic may experience exponential decay and ultimately meet its end (according to the Washington Post).
- The Food and Drug Administration (FDA) approved Pfizer’s BioNTech COVID-19 vaccine for ages 12-15. It is the first and only FDA-approved vaccine for children in this age group.
Keeping Up with Inflation
- The Consumer Price Index (a measure of inflation) was up 4.2% this April vs. the same month last year. This is an artificially high number because prices were depressed by the pandemic last year.
- Some economists argue that higher prices in commodities and rising prices from producers will cause inflation to overshoot the Fed’s average inflation target rate of 2%. Market participants fear that our Central Bank will be forced to taper more quickly than the market anticipates.
- However, Federal Reserve governor, Christopher Waller, stated that the Fed should not move too quickly in chasing inflationary ghosts.
- Separately, job openings, measured by the Job Openings and Labor Turnover Survey (JOLTS), are at a 10-year high. This is a very positive sign for the labor market but could signal wage inflation ahead.
Making Records
- Earnings season is winding down. Over 91% of the companies in the S&P 500 index have reported their earnings.
- S&P 500 earnings grew by about 49% in the first quarter vs. the same period a year ago, marking the fastest earnings growth since 2010.
- The largest contributors to the earnings growth came from the Financials sector, followed by Technology, Communications, and Consumer Discretionary.
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