Inflation has become a topic at the forefront for investors and policy makers. It’s present and it’s felt, but key questions revolve around its trajectory, what the main drivers are and whether it is transitory.
April core CPI (Consumer Price Index) jumped to 3% year-on-year (significantly above the 2.3% consensus estimate) and was not all due to “base effects” (coming off a shut-down economy last year). The 0.9% month-on-month uptick was the highest since the early 1980’s. Shortages in supply chains, stimulus money blanketing the system and business re-openings all have the ability to create pricing pressure as demand exceeds supply. As stimulus is absorbed and abates and supply bottlenecks work themselves out, and productivity increases with more labor force participation, it is reasonable to think that inflationary pressures will ease.
Still, inflation and inflation expectations exert pressure on equity valuations, particularly for stocks whose prices are more dependent on quickly growing revenues and cash flows, namely growth stocks. Inflation directly affects the rate at which future cash flows are discounted to arrive at today’s value. In a rising or high inflation environment money in the future becomes less valuable in current terms. This a significant factor in the sector rotation we have seen so far in 2021 compared to last year. Energy and Financials have led the S&P 500 sector performance by large margins, while Information Technology has been relegated to the worst performing. This also could prove transitory, but it has shined a spotlight on some of our favored industries and names in the value sphere.
There was a pullback in the large equity indices mid-May that afforded some brief buying opportunities but now we’re back on an upward trajectory. In broad terms, fundamentals are looking sound with solid earnings growth and many companies and analysts upwardly revising future estimates. The Fed remains accommodative and there is a certain wait-and-see sentiment pervading economic and market outlooks, with a definite skew to the positive. We also remain positive and are, naturally, on board with value investment coming back to the limelight!