The Temperature is Rising… What about Inflation?
Updated: May 26
It’s nearly Memorial Day weekend, and perhaps you’re looking forward to mask-free barbecues with your fully-vaxed friends or packing up your kids for their sleepaway camps – yes, they don’t leave for weeks, but it’s never too early to prepare. Maybe you’ve invested in some new patio furniture for your mask-less barbecues that you feel you’ll never see due to widespread manufacturing supply chain disruptions. The pandemic shutdown and regulatory restrictions on materials and manufacturing have resulted in an undersupplied market. In the meantime, demand is heating up as the economy re-opens and consumers spend more. This supply-demand imbalance, coupled with excessive money supply from the federal government, is contributing to fears that higher inflation may be coming.
While markets have been volatile and seemed to overreact to this threat of rising inflation recently, corporate earnings reports, as a whole, have been strong. Rising interest rates may continue to shift the growth/value dynamic in the latter’s favor given that value stocks are typically punished less in rising interest rate environments than their growth stock counterparts. Furthermore, as the economy reopens, large technology companies that were beneficiaries of the stay-at-home, work-from-home world may see their earnings grow more slowly relative to other companies and sectors.
Both growth and value stocks can be profitable investments over the long-term, so investors may not want to make drastic changes to their portfolio by rotating out of technology/growth stocks and into value stocks. If you are in the income-earning tax bracket that might be affected by proposed changes in capital gains tax rates, you may want to speak with your tax advisor about opportunistically realizing some of those long-term gains in 2021. Also, if you are seeking to deploy cash into investments that may be less impacted by inflation, you may want to consider emerging markets equities or floating rate credit with limited duration (think middle market lending).
As we approach the summer months, some factors that may be at play in determining 2021’s market growth and economic outcomes include:
Globally divergent economic recoveries reflecting variations in pandemic-induced disruptions and the extent of policy support
“Dovish” Fed policy – they’ve said they’re not going to raise rates and may not for years – we’ll see
Corporate earnings – they’re expected to normalize in 2021, with some scenarios pointing to a complete recovery in earnings by the fourth quarter
Possible new government stimulus of $2.1 trillion
Elon Musk tweets roiling the markets – let’s hope his acting career is done after his recent Saturday Night Live appearance
Biden’s tax agenda, both for corporations and individuals
Continued elevated levels of stock market volatility
Great Gatsby style, “hot vax summer” parties – not really, but consumer spending is certainly a factor
US dollar depreciation
The ongoing trade war with China and other geopolitical forces
Facebook, Google and Amazon under pressure from DOJ antitrust and privacy investigations
Return to work in person/”hybrid” work and the impact on the office real estate market
Whether the bump in inflation proves to be temporary or longer lasting, as in enough to force a shift in Fed guidance, is likely to remain a hot topic for months to come. More clarity may be on the horizon for August, when the world’s central bankers meet at their annual Jackson Hole symposium, an occasion that is often used to make important policy announcements. In the meantime, I’d expect it to continue to be a bumpy ride in the stock markets, but if you have conviction in your portfolio allocation, you should try not to obsess over the daily or even weekly fluctuations. Head outside for some quarantine-free summer fun and try to remember how to socialize normally, without talking about whether you received the Pfizer or Moderna vaccine. And give someone (you know) a hug.