I have been worrying about inflation, particularly wage inflation, as our economy reopens. Inflation can crush the valuations of growth stocks and other “long duration” assets. However, the spreading of COVID’s delta variant and recent indications of a quicker economic slowdown — albeit from a blistering, unsustainable pace — than I had expected have made me more sanguine about the market although this may sound counterintuitive. I bet that our central bank, the Federal Reserve Board (Fed), which holds all the cards that really drive the market, will maintain its accommodative monetary policies longer than most investors, including me, had expected a few months ago.
At the beginning of 2021, the consensus was that our recovering economy and inflationary pressures would drive America’s “risk-free” interest rate, or the yield on the 10-year Treasury note, from 0.92% to at least 2.00% by year end. Those forecasters were right…for a while. The yield peaked at 1.77% on March 30, but since then it has plunged to today’s (August 20) 1.26%. Investors that trade Treasury bonds are telling us that the inflation pressure is off, or we have at least seen the worst of it. If the Fed “tapers” its monthly purchases of Treasury and mortgage-backed bonds, which it buys to lower long-term rates to resuscitate our economy, we could have a “taper tantrum” correction in stocks, but I think that it will be short-lived and not too deep. I likely would see it as a buying opportunity. It sure was when this term was coined and after the market was rocked after Fed Chairman Ben Bernanke threatened to raise rates in 2013.
I am not saying that our departure from Afghanistan is not a critical geopolitical issue — it clearly is — but it does not worry this investor. The key things to watch are the spread of the delta variant to see if it will meaningfully slow our economy again, and the Fed’s next move. Of course, these hot buttons are related. I give “honorable” mention to two other worries, which are the world’s scarcity of semiconductors — I suggest that you read Al Root’s “The Chip Shortage Looks Like the Oil Shortage of the 1970s” in this weekend’s (August 23) Barron’s — and the struggle that analysts face in determining for businesses that have benefited from COVID how much of their demand remains if and when we beat the pandemic.
Check out Paul’s recent commentary, Two Doesn’t Usually Make A Trend But What If It Does This Time? for more information.