Inflation readings were scary in April and May with the Consumer Price Index (CPI) up a respective 4.2% and 5.0%. Why should you care? If you think that inflation is transitory then you should not worry. That is our central bank’s — the Federal Reserve Board’s — official stance. It continues to support the US economy through unprecedented monetary stimulus. Specifically, the Fed has pinned its Fed Funds rate to the floor, and it has been buying $120 billion of Treasury and mortgage-backed bonds per month in this effort. So far between its boost and that provided by Congress through fiscal policy spending America has thrown over $8 trillion at COVID relief. To put this in perspective, US gross domestic product in pre-pandemic 2019 was $22 trillion.
The bulls who are driving US stocks higher — the S&P 500 was +15% (through June 2021) and historically +10% is a solid year — are in the Fed’s camp, which means they believe that inflation and thus this spike in interest rates is fleeting and that both will subside once we fully reopen our economy and supply chains are unclogged.
The bears fear that inflation is structural and that it will get worse particularly if wage inflation spirals out of control. No one thinks that we will return to peak 14.8% (March 1980 CPI) inflation, but there is still room for a lot of damage between last month’s 5.0% print and that Armageddon.
I am neither a card-carrying inflation bull nor bear, but because the bear case is so nasty I am leaning in that direction just to best prepare for it. Therefore, I am embracing the rotation from growth to value stocks, particularly to dividend payers, although I am best known as a technology investor. The economic sectors that I have benefited from owning during this market shift are financials, industrials, energy, and materials. In particular, energy has been a winner with the price of oil has increased +56% (through June 2021). For my technology investors, I have raised cash or have repositioned portfolios in stocks that are less impacted by rising inflation and rates, which have disproportionately hurt yesterday’s highflyers.
These have been smart bets in 2021 although the market has rotated back into growth and technology names in recent weeks since the yield on the 10-year US Treasury note — aka America’s risk-free rate — peaked (but just for now?) and then retreated from 1.75% in March to 1.44%.* I am not yet convinced that all is well and that the inflation bulls have won. I hear too many companies complaining about rising costs, particularly critical wage inflation. When McDonald’s is paying hiring bonuses — it is — like a New York investment bank then we should all be wary.
For 2021’s second half, I think that stocks will go modestly higher and that if we have any correction that it will be quick and shallow (i.e.., no worse than -10%). So, I do not quibble with owning equities. In fact, I would be fully invested. However, I continue to be worried about the stock portfolio mix; and I am leaning into the batten-down-the-hatches trade in case inflation proves to be worse and stickier than thought.
Check out John Thur’s past commentary, Is the Market in Hype, Hope, or Realistic Mode?