Why Dow, S&P aren’t as involved about inflation as everybody else
Jamie Dimon, CEO of JPMorgan, is so concerned about inflation that he will not invest Wall Street bank money. Homebuyers are pulling out of the market amid a price frenzy and used car stickers are now a bigger deal than new car prices on the dealership.
It’s not news that inflation is running hot. The consumer price index’s increase of over 5% in May was the highest since 2008. If food and energy prices are removed from these inflationary pressures, it was the highest level since January 1992. Producer prices, meanwhile, rose the fastest in over a decade. And according to a survey by the Federal Reserve Bank of New York, consumer inflation fears are also at record levels.
So a good question: why is the S&P 500 index breaking new records, the Dow hanging close, albeit slightly below a post-pandemic rally record, and the Nasdaq having a seven-day winning streak just before the end of the Fed meeting on Wednesday ? All three major stock market indices are now between about 90% (the Dow) and over 110% (Nasdaq) above their pandemic lows.
For Nick Colas, co-founder of DataTrek Research, all comparisons between current inflation numbers and past records are interesting for market historians, but less relevant for the stock market outlook. Stock futures were subdued on Wednesday ahead of the Fed.
A patient bond market is key
The reason for his bullish view amid inflation fears and the number he thinks is more important than the CPI: the bond market. It signals patience.
Despite the hot inflationary pressures, government bond yields remain low. Yes, inflation numbers can be real – and a legitimate concern for the bears, especially when they point to home and rental prices – but market historians should also note that the bond market has historically been slow to respond to inflation trends.
The 10-year Treasury yield is still around 1.5%.
The bond market is not signaling an inflationary environment that will last and Colas is ready to bet that the bond market is a better betting provider than Jamie Dimon right now.
“Government bond yields are not wrong,” he said. “If you think [inflation] will come back roaring, don’t be in bonds, don’t be in stocks. “
His bullish view of why the bond market is patient is that all of the factors driving inflation are temporary, as the Fed has repeatedly said. This also includes used car prices, which are skyrocketing not only because of the financial and monetary increase in purchasing power of car buyers, but also because of the shortage of chips on the car market and the lower supply of new cars. Factoring out the short-term factors, the CPI is actually close to where it was just before the U.S. pandemic, a little above the 2% mark from February 2020.
The exception that supports the bears: home price and rent inflation, which is less of a temporary burden and may be a drag on the economy.
Housing affordability is one of the issues that can test how cautious the Fed is, Michael Englund, chief economist at Action Economics, told CNBC earlier this year in anticipation of the summer’s inflation records. He said some of the price comparisons might be short-term and expected given the year-over-year change caused by the pandemic closings, but home and rental prices are inflationary pressures that make up the FOMC meetings in June and July and semi-annual monetary policy Testimony to Congress on Capitol Hill, events to watch out for for signs of a possible change in rhetoric.
Sticking to the temporary inflation argument, “could fall on deaf ears in the summer when the Fed steps up before Congress,” Englund told CNBC.
From this data, however, Colas concludes that while housing inflation will continue to rise, history has it that that alone is not enough to keep CPI up quickly when other factors such as energy, used cars, auto insurance and airfares are the latest Increase drove – are “safe in the temporary inflation camp”.
Beware of stocks, don’t panic with inflation
Yields have fallen from their March highs, and that helped lift the S&P to a new all-time record.
Colas is now cautious on stocks but not bearish on the market due to fears of a more restrictive Fed.
“We have been a little cautious (but not pessimistic) on US stocks lately, and a modest new high alone is not enough to change our minds,” he wrote to clients after last week’s CPI. “Of course, a good part of our ‘no secular inflation’ thesis is already priced into Treasuries. As a result, Big Tech should see a little catching-up that will only happen when companies report the second quarter in July and signal their outlook for the rest of 2021. “
His overall picture is that while markets can experience short-term periods of panic related to bonds and stocks – the shortest time is the tendency for stocks to fall during the post-Fed commentary of the Powell session – the bond market is often a long one Really catching up on inflation. Historians can trace any CPI back to the 1950s if they like, but Colas noted that the time he is looking at is when the US passed its last major period of inflation, which ended in the 1980s and inflation fell. from double-digit percentages to 2%. It took the government bond market 20 years to accept that US inflation was beaten
“Bottom line: This is exactly why 10-year Treasuries even ignore 1-2 years of CPI data,” he recently wrote in a message to DataTrek customers.
The lesson: “The treasury market is a ‘show me’ market,” Colas told CNBC. “It wants inflation to go up or down for a long time before it is reevaluated. … The high inflation this year says nothing about the future and before the pandemic because we had such low inflation. [the bond market] will need a lot of evidence before inflation rises again, “said Colas.
Investors don’t expect a restrictive Fed
“Predicting inflation is basically predicting interest rates. That has been a stupid concern for the past 12 years,” said Mitch Goldberg, president of investment advisory firm ClientFirst Strategy. He believes that general inflation caused by supply imbalances is temporary and will ultimately be mitigated by higher levels of production around the world, while wage inflation could prove stickier but manageable, with much of the spike in wage growth coming from short-term and one-off hikes is due to bonuses.
Market pros don’t expect a sudden turn in the Fed’s thinking or belief that inflation is “transitory”.
According to a fund manager survey by Bank of America, about three-quarters of professional investors agree with the Fed.
“It’s hard to say it is [going to be] hawkish because … I think it’s going from overly reticent to overly reticent, “Rick Rieder, Blackrock’s chief investment officer, global fixed income, told CNBC.
There may be more disagreement among Fed members, but a rate hike is not expected until at least 2023, and many traders are ready to believe the Fed’s position will remain on Wednesday. “Some of these restrictive expectations are exaggerated,” Michael Arone, State Street’s chief investment strategist for the US SPDR business, told CNBC. “Powell will say the labor market has 7.5 million jobs left before it goes back to where it was.”
For Colas, what bonds have to say will remain the more important market commentary.