Potential Higher Than Expected Inflation Scared The Markets
The markets have been under pressure this week with the tech heavy NASDAQ Composite taking the biggest hit of the major indexes. This week, through Thursday’s market close, the S&P 500 is down 2.84%, while the Dow Jones Industrial Average has declined 2.17% and the NASDAQ Composite has sold-off 4.56%.
Stocks were under pressure at the start of the week and the sell-off was exacerbated by the latest April CPI figures that showed inflation was higher last month than what economist had expected. That brought back concerns that inflation will force the Federal Reserve to raise short-term interest rates faster than anticipated. On the long end of the yield curve, the 10-Year US Treasury yield increased to 1.66% by Thursday evening.
The market does not want higher long-term interest rates because that means the cashflows produced by stocks are discounted at a higher rate, which forces equity prices lower. Technology and growth stocks are affected the most because their projected cashflows are expected farther down the line. The farther the cashflows, the more it is discounted and lowers the stock price. That is why the tech heavy NASDAQ Composite was the worst performer this week.
We are not overly concerned about higher-than-expected inflation at this moment. Sure, the April inflation figures came in higher than expected, but remember the 4.2% headline figure is comparing year-over-year growth. Last year in April, we were in the midst of the COVID-19 pandemic and the economy was shut down, so of course, inflation is going to look much higher today than it did last year. The Federal Reserve also believes that we will see inflation over the next few months, but it will be transitory.
We are not surprised the markets have sold-off this week. We talked about this very topic on our quarterly commentary. Longer term it is going to be challenging for inflation to persist because once the sugar high ends from all the fiscal and monetary stimulus, the economy will return to pre-pandemic anemic real GDP growth. We view the technology sell-off as an opportunity to purchase stocks at a lower price and are not concerned longer term. We have a solid investment strategy for our clients and the data tells us there is no need to deviate from it. We will continue to stay disciplined and find opportunities as the markets pullback.