It was just six months ago that Fed Chairman, Jerome Powell, was making the case that inflation was temporary and acting too aggressively would be a grave mistake (Reuters). For their part, President Joe Biden and White House staff having been making much the same argument that inflation is “transitory” and even making the dubious claim that another $4.5 trillion in government debt-generated stimulus spending (CBO, 10-year estimates) for “Build Back Better” would actually reduce inflation!
The January CPI figures were released and the market’s worst fees were confirmed. Inflation isn’t moderating at all, but instead now has reached a 40-year high level that makes it all the more certain that the Fed will have to raise interest rates aggressively in 2022 and 2023.
The latest CPI data shows that inflation increased 7.5% over the 12 months ending January, 2022. This is the steepest annual increase since February, 1982, and shows inflation gathering steam even over December’s year-over-year figure of 7.0%. In fact, if anything, inflation appears to be accelerating, averaging 8% over the last 3 months. As would be expected, the worsening inflation situation is having a major impact on stock markets. Whereas the markets were mostly up or level until the latest inflation figure was released, stocks immediately began selling off as soon as the announcement was made. The Dow ended the day down 1.47% while the NASDAQ ended down 2.1%. As we’ve seen over the last few weeks with inflation data coming in worse than expected, major growth stocks like Microsoft and Apple sold off very heavily today while stocks of boring dividend payers like Coca Cola and Merck managed to weather today’s storm relatively well. If the reason for this puzzles you, it is because when inflation rises, the value of future returns (dollars) from growth stocks lose value while the strong current returns and dividends from slow growing but cashflow rich companies “blue chips” rise in value.
This market trend away from growth and toward dividend paying “value” stocks has been something we’ve been aware of for weeks now and, for this reason, we have been making continuous adjustments to our portfolios to reflect this new reality.
The other concern we have is how high might interest rates have to rise in order to tame inflation. With the announcement of the CPI data, the probability of a 0.5% rise in interest rates in March by the Fed now rises to about 50% (from a 30% likelihood before). Moreover, instead of the 3 interest rates hikes (of 0.25%) over 2022, the market is now anticipating as many as 6 interest rate hikes of 0.50%. With such a rapid increase possible over the course of the year, it’s not hard to imagine that consumer loan interest rates are likely headed higher as well- possibly much higher. Already, the 10-year treasury yield surpassed 2%, after being as low as 1.23% just last July 1. A 30-year fixed conventional mortgage that last summer could be had for around 2.75% (0 points) now goes for around 3.875%, or higher. We can expect these increasing interest rate trends to continue to play out in the stock and housing markets over the next few months, as consumers and investors alike rethink their strategies given the higher cost of money and reduced spending power that inflation brings.
*This is for informational purposes only and not meant as investment advice or a recommendation to buy or sell any specific securities. All investing involves risk, and there is no guarantee that historical performance will be repeated. Indexes discussed are unmanaged and cannot be invested into directly.