Inflation

Hello,

We are sending out a quick Peter’s Perspective via email this week as our COO and video tech (and network admin and HR expert and etc…) is currently out taking care of his new baby Julia.

I want to note that since the end of April, we have had a bit of a volatile patch in the market. For example, from May 7th to May 12th the market as represented by the S&P 500 Index was down 4.01%, but as of the close of market on 5.20.2021 is now down only 1.87% since May 7th. And, the more tech heavy Nasdaq Composite Index had a drop of 7.67% from April 29th to May 12th, but has, as of market close on 05.20.2021, recovered to be only -3.69% since April 29th.

While the upward trajectory of the current bull market may have anchored investors’ expectations in such a way as to make any downward price action seem concerning, I would like to remind you that moderate pullbacks are not only common, but they are also the way that the market corrects imbalances before they become more of a system-wide risk. In fact, the S&P 500 will historically have more than three 5% pullbacks, on average, in any given year. Also, typically one of those 5% pullbacks will turn into a 10% drawdown, on average.

The main concerns that you are seeing in the news are likely revolving around inflation increases. As discussed in the last Peter’s Perspective video, I believe that inflation levels are normalizing after the Covid-19 dislocation. I am also skeptical that this normalizing process is as damaging to established technology stocks as some market participants seem to believe, given that these tech products that have become so ingrained into our lives still have, in my opinion, significant pricing power.

With that said, given the size of the Covid-19 dislocation, it is not unreasonable to anticipate that the normalization process will produce some aftershocks. The global supply chain is certainly seeing unusual stresses as the flow of goods starts up again.

As a broad range of prices have been impacted, the most recent inflation data has not been at all moderate or normal, so the news flow continues to reiterate concern. To reinforce my analysis, I would like to include a quote from a piece published on May 14th, 2021 by Larry Adam, the Raymond James Chief Investment Officer:

“With this week’s year-over-year CPI figure surging to 4.2% — the fastest pace since 2008 — and core CPI (excludes food and energy) prices posting their largest monthly gain since 1981, concerns intensified that this inflationary spike may be more than what the Federal Reserve has telegraphed as ‘transitory.’ However, we disagree and firmly believe that this spike will likely peak during the third quarter at the latest, and settle down by year end. It is important to understand that we are in the midst of the most critical part of the ‘base effect’ as prices today are being compared to the severely depressed levels at this time last year —a time where demand was non-existent as the economy was in the middle of a lockdown. So, while some of these increases are eye-popping as consumers are simultaneously coming out of spending hibernation, they need to be put into perspective. For example, while airline fares and hotel prices posted near record month-over-month increases, these two industries remain 18% and 6% below pre-pandemic levels. As we progress through the summer, pent-up demand, supply-chain bottlenecks and shortages should subside and inflation should normalize. Our (Raymond James’) economist, Scott Brown, believes that core inflation will trend to 2.9% and 2.2% by the end of 2021 and 2022 respectively.”

While I am still working though some of the more detailed points on our three-legged stool model in the View on the Market Series, I do want to point out that all three legs and the seat remain stable and are providing solid support to the market. Valuations remain reasonable for stocks given the current real return on bonds and rising earnings expectations; the economy continues to run strong, with a strong print for the Leading Economic Indicators today (05/20/2021); and there is no sign of broad market stress outside of some of the more recent equity price action, none of which is pushing major indices below their 200 day-moving-average.

Interest rates appear to have moderated for now, though there is a great deal of concern as to when the U.S Federal Reserve (the Fed) might start to wind down (taper) their bond buying program. While this will likely cause some level of market impact, it is far from certain as to when it will occur or what the capital markets will look like at the time; therefore, impacts to the three-legged stool model on that front remain highly uncertain at best.

I’m Peter, and that’s my Perspective.