Due to the manic movements of the market on the Fed, inflation cannot peak until the summer

Last week’s market action was another example of a push and pull between stocks, bonds and the Federal Reserve, which investors would expect to see more in 2021. investors may not worry until the summer.

The Dow Jones Industrial Average hit another new record last week – and Dow futures were strong on Sunday – as some sectors favored in a spin away from gaining growth, including financial and industrial services, and received further support from the new round of federal stimulus measures, while the latest inflation rate fell below estimates. The Nasdaq rebounded sharply and beaten up, big success stories in 2020, like Tesla, rallied. But investors looking for a clear signal to send out didn’t get one, as the technology was sold to close out the week with a 10-year treasury yield hitting a one-year high on Friday.

This week’s Fed meeting on Tuesday and Wednesday may trigger action in yields and growth stocks, but as Fed Chairman Jerome Powell is expected to maintain his moderate stance, some bond and stock market experts are looking a little further ahead, towards the May July period, as a key for investors. An important data point supports that view: inflation is expected to peak in May in May and mark a dramatic rise.

According to an Action Economics forecast, year-on-year increases in the consumer price index (CPI) will peak at 3.7% for the overall figure and 2.3% for core inflation in May. That should come as no surprise. As the US is celebrating its one-year anniversary from the start of the pandemic, it is the May-to-May equation that captures the shutdowns that gripped the country last spring and will now serve to boost May’s inflation sprint.

But even if this arrives, the steep rise in inflation over the next few months will likely add to investors’ concerns that the Fed may still undervalue upside inflation risks. It is only a matter of time before the economy fully opens up and economic expansion takes place at a pace that will pull inflation and interest rates higher.

Belief is growing on Wall Street that an era of low interest rates and low inflation is coming to an end and that a turnaround is imminent.

“We’ve been through a very compliant period in terms of rates and inflation and that’s over,” said Lew Altfest of New York City-based Altfest Personal Wealth Management. “The bottom has been laid and rates will work up there again and so will inflation, but not so dramatically.”

“It’s the speed that most worries investors,” said Sam Stovall, CFRA’s chief investment strategist. “Inflation will of course increase and we are spoiled for choice 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 what’s called the ‘dot plot’ – members’ outlook as to when short-term interest rates will rise, and that may not change to any significant degree, even though many members don’t need to their view to move the median. But it’s the summer when the market will put pressure on the Fed on a higher inflation path.

“It is a good bet that there is higher inflation, higher GDP and tightening on the horizon,” said Mike Englund, chief executive officer and chief economist of Action Economics. “Powell doesn’t want to talk about that, but this is the table for that summer discussion as inflation is peaking and the Fed gives no ground.”

As of now, Action Economics predicts that inflation will increase moderately in Q3 and Q4 and that interest rates, in anticipation of CPI movements, will hover around the 1.50% average in Q3 and Q4. But Englund is concerned.

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

Some of the year-over-year comparisons of inflation rates, such as commodities plunging last year, are to be expected.

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

But there is evidence in several commodity sectors of continued profits and upward price pressures in residential real estate, which is measured not as part of core inflation, but as an economic ramification of inflationary conditions. There is currently a record low supply of existing homes for sale.

These are inflationary pressures that make the June and July FOMC meeting and the semi-annual monetary policy testimony to Congress on Capitol Hill potentially more consistent Fed moments for the market.

As housing affordability decreases and commodity prices rise, it will be more difficult to tell the public that there is no inflation problem. “It could fall on deaf ears in the summer when the Fed comes before Congress,” Englund said.

Altfest is capitalizing on residential inflation in its investment outlook. His company starts a residential real estate fund because it benefits from an inflationary environment. “Stock volatility will persist given the strong pluses and minuses and hiding in the private market, focusing on cash yields and not prices in a volatile stock market, is reassuring to people,” he said.

History shows that companies can pass on price increases to their customers as rates and inflation increase with economic activity. Last week, investors were delighted to be able to combine profits for four consecutive days. But according to Stovall, investors in the stock market have also been spoiled by the surge in stocks, so while the trajectory is even higher, the rise angle has narrowed.

“ If there was a guarantee that we will only see a revival in inflation and interest rates in the short term and if we get past Q2, which looks drastically stronger than 2020, a guarantee that the second half would see a moderation in inflation and interest rates, investors wouldn’t do that. be concerned, ”he said.

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

“That adds to the agita,” said Stovall.

Altfest’s customers are divided between the manic “Biden bulls” who see a period like the Roaring 20s ahead, and the depressives, the “Grantham bears”.

He says both could be right. Interest rates can continue to rise while corporate profits can pick up. More profit equals a better stock market, while higher interest rates put pressure on price-earnings relationships and offer more opportunities.

For bonds to be a true competitor to stocks, interest rates need to be above 3%, and until the market gets close to that, Altfest says the bond market’s effect on stocks will be overshadowed by economic growth potential and the outlook for corporate earnings. Value remains much cheaper than growth even as those stocks and sectors have recovered since the fourth quarter of last year, although he is more focused on foreign stocks that will benefit from increased global economic demand and have not progressed as fast as the American market.

For many investors, there may not be enough confidence to add to importance as we get closer to the “May sell and go” summer Wall Street period. But there will also be more money coming off the sidelines that can flow into stock prices relatively quickly, partly due to the stimulus payments to Americans who don’t need the money to cover daily expenses, and that could help keep stock prices in the short term. jacking up, Stovall said. .

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

The “May sale” theory is a misnomer. According to CFRA data, the average price change of stocks during the period from May to October is better than the available return of cash dating back to World War II, and 63% of the time the stock gained during the period. “If you have a 50-50 odds and the average return is better than cash, why would you have taxable consequences reselling,” Stovall asked. “That’s why I always say it’s better to turn off than back off.”

And for now, the stock market worked for investors through the rotation in value and out of technology, although last week’s Nasdaq gains suggested investors are watching for signs of stabilization there. The sector performance since the last S&P 500 correction in September 2020 shows that the best performing segments of the market are energy, financial services, materials and industrials.

“The very sectors that do best in an environment where the yield curve is getting steeper,” said Stovall. “While the Fed continues to dig in its heels not to raise rates, those are the sectors that are doing well.”

Investors who had already settled on this market were wrong, and investors rarely prefer a trend at work. That is why Stovall’s vision continues to “rotate rather than retreat,” and more money in value and out of growth, as stock market investors continue to stick to the companies operating in an environment with a steeper yield curve.

He also pointed to a technical factor to keep an eye on for the summer. On average, there is a period of 283 days between S&P 500 declines of 5% or more dating back to World War II. It has been 190 days since last week, which means that the market is not “really expected” until 90 days – or in other words, the start of summer.

By summer, the anecdotal price evidence will work against the Fed. A faster recovery abroad, such as in the European economy lagging behind the US, could also accelerate global demand and commodity markets.

In terms of both inflation and the stock outlook, investors will face a similar problem in the coming months: “You don’t know you’re at the top until you start the downtrend,” Englund said.