U.S. stocks closed slightly higher yesterday as recent speeches by Fed officials helped curb fears of out-of-control inflation.
Due to the accelerated economic recovery and market concerns about inflation, the US stock market has recently entered a period of volatility.
Felix Wintle, manager of the Tyndall North American Fund, says: “We certainly live in a time of extreme data. The US economy is currently experiencing its highest level of growth since the second world war, and inflation is also giving us readings that are way higher than most investors have ever seen in their lifetime. Coupled with this is the many trillions of dollars that have been printed and distributed by the Government to support those affected by the pandemic.”
However, he believes there should be plenty more Dollars to come to support recovery: he points out that US consumers are emerging from the recession in better shape than they went into it. Richard de Lisle, manager of the VT De Lisle America Fund, says: “The US recovery seems back-end loaded to us and is just getting started, so will last a long, long time. The bit we’re focused on is the infrastructure plan, which is all about building roads and bridges over the next eight years.”
The question is whether higher inflation forces the hand of the Federal Reserve, as Summers predicts, pushing a snap rise in rates and an economic and market shock. De Lisle is not worried: “We don’t expect inflation will dampen growth given that savings rates are a record high, there is a pledge by the Fed to keep rates lower for longer and there is a post lockdown behavioural change in the desire to spend.”
In a mid-year outlook, chief cross-asset strategist Andrew Sheets said investors face a “hotter, shorter” economic cycle for the first time in a decade thanks to outsized fiscal stimulus, monetary easing, ramping vaccinations and the highest consumer savings rates in history. But the potential for higher inflation, tighter policy, margin pressure and increased taxes could weigh on returns, leading the firm to dial back its exposure to risk assets like credit and stocks.
“Strong economic winds also bring complications,” Sheets wrote in the report published Sunday. “Just 14 months from the lows, investors face early-cycle timing, increasingly mid-cycle conditions and late-cycle valuations.”
The Market Is Tired
The market volatility appears to be tied to the possibility that inflation in the United States will be picking up, leaving open the question about whether or not the Federal Reserve will continue to maintain its “accommodative” monetary policy stance, something that it has been holding onto for a long, long time.
This uncertainty is impacting the investment community resulting in a greater volatility in the actual movement in prices. This can be seen in the accompanying chart plotting the movement in the VIX measure of stock price volatility.
The VIX number had been relatively stable up to the past week or two, but with the investor furor related to possible Federal Reserve actions, the volatility has moved up in the past two weeks.
Paul O’Connor, of Janus Henderson, is quoted in the Wall Street Journal: “the context of this week is that markets are tired. Stocks keep losing momentum, speculative areas of the market are losing momentum.”
However, even if the US economy is only in the foothills of recovery, it doesn’t mean that it will be good news for the stock market. James Spence, managing partner and portfolio manager of the Cerno Global Leaders fund, points out that valuations have seen unprecedented expansion as bond yields have dropped: “Markets have had 37 years of valuation gains based on falling bond yields. Whether there is inflation or not, today we have the prospect of rising bond yields. Investors can’t rely on valuation gains from here, so there is a clear negative in that column."
He adds: “While it is right to be optimistic on growth, there will be a disparity between the economy and financial assets. Bonds and equities have gone up together and it is a long time since anyone expected anything different.”
It won’t be a good time to be an index investor, says Spence, who thinks the tech sector’s run of luck is over. Scott Spencer, fund manager at BMO Global Asset Management, agrees that growth stocks in general have probably had their moment: “When we look at the Goldman Sachs index of technology companies that don’t make a profit, it has outperformed both the S&P and the FANG index." He says that along with non-profitable tech, there has also been strong performance from non-profitable IPOs in 2020. Indeed, 80% of the companies that went public did not make a profit in the 12 months prior to their listing, but their 2020 returns were still over 100%. He adds: "2020 will go down as one of the best years ever for growth investing.”
"Value" options offer more compelling valuations but are a smaller part of the index in the US. That said, Spence cautions against going full value, given recent performance and that some value sectors, such as energy and financials, are quite challenged. Spencer is maintaining an underweight position in the US across the BMO portfolios given the overall value of the market. Where they do hold the US, they are retaining a value bias, though this has reduced somewhat after a recent strong performance.
It may not be the end of the party for the US economy, but there is certainty some change ahead in the US stock market. Investors are likely to see a growing disconnect between a tougher stock market environment and buoyant economic figures.
Investors need to be very edgy at this time and need to be able to move if things seem to start moving against them.
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