Is Inflation About to Become Yesterday’s Story?
The first Investments course I took as a third-year college student had a section on Real Estate. The one lesson I remember the professor drilling into our heads was the well-known “Location, Location, Location…” For nearly a year now, stock and bond markets have been driven by a similar sounding theme:
“Inflation, Inflation, Inflation…”
The S&P 500’s 16% second quarter loss capped its worst first half since 1970, bringing its year-to-date decline to 20%. Several factors contributed to the stock market selloff that began late in 2021, and all can be linked to inflation – either as a cause or result:
· Supply chain issues drove prices higher
· The war in Ukraine caused global food and energy shortages
· The Federal Reserve was seen as behind the curve in fighting inflation
· The Fed then began raising rates rapidly, leading to recession fears
Bond holdings provided no buffer against stock market volatility, as higher rates created losses. On top of that, many investors were overweight in the “darlings” of the stock market – high-growth companies focused on technology and innovation. This combination of factors – again, all connected to the inflation narrative, has created pain.
Markets have fared much better in July, although it remains to be seen whether this is the proverbial “dead cat bounce”, i.e., a relief rally in an ongoing bear market, or the start of better times. Regardless of the short-term outlook, staying with a plan is important for long-term success. Often markets recover when least expected, and “getting out” after a decline could lead to missing the recovery. In 1970, the S&P lost 21% in the first half of the year only to rebound by over 26% in the second half to finish the year roughly flat.
There are potential reasons for a recovery, as inflation has likely peaked. The last Consumer Price Index (CPI) report showed another spike, but a big contributor was the price of gasoline which has now fallen by more than 10%. Most other commodity prices have eased, and the Federal Reserve’s aggressive tightening is already slowing the economy. In fact, I would argue that the possibility of a recession is now more of a concern than the current inflation outlook. Fortunately, corporate and personal balance sheets are in far better shape than 15 years ago, and a recession is likely to be mild and potentially over before it is officially recognized.
I believe long-term investors should be more inclined to buy than sell, particularly if they are underinvested in equities. And I expect that in the weeks to come the narrative will move away from the negative inflation story.
David Maley
July 29, 2022
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