Inflation and Interest rates
We’ve not heard much about either of these two market slayers of late. Barron’s year-end edition brings them back into focus –– “What Inflation Could Mean for the Market – Even a small uptick could catch markets off-guard. How to prepare.” We all know that higher inflation, and the higher interest rates that will ensue, will destroy the market. Or, at least, this would appear to be the common wisdom. This was the common fear, much played up by the media and punditry, on the end of Quantitative Easing (QE), the beginning of Fed rate increases and the current withdrawal of QE (the slow shrinking of the Fed balance sheet). How did avoiding stocks in the face of these much advertised market killers work out? I think not too good.
In my last post of 2017 (“Strange disconnect … ) I labeled higher interest rates as the markets next ‘big thing’ to worry about (the more things change, there more they stay the same). These higher rates would probably be a result of the US economy running a bit hotter on the inflation front. That higher rate of inflation would probably emanate from a combination of ingredients — an already strong US economy, low unemployment bolstered by lower taxes and a worldwide synchronized economic recovery. My conclusion:
Higher rates are probably coming as a result of the potential inflationary effect of the tax cuts (probably even without tax cuts) and improving worldwide economies. This would be normal (to be expected) and the higher rates MAY give way to a significant correction in stocks … after which the secular bull market resumes.
Having stated the above, I still do not believe the slow shrinkage of the Fed balance sheet will be a big contributor to any increases.
I stand by this position
First of all I believe a moderate bump in the rate of inflation to, say, 2.5% to 3% is a good thing because it will soothe the minds of all those who have been worried about disinflation. Remember, it was just two years ago this month when many market participants were circling the wagons due to the perception that falling commodity prices were forecasting a decrease in worldwide demand, signaling an imminent recession. Of course, as I said repeatedly at the time, it was all about oversupply, not demand (kortsessions -12/21/2015 – If everything is so good, why do we feel so bad?)
“According to the International Energy Agency, 2015 demand for crude oil increased by 1.8 million barrels per day. They are estimating in 2016 that number will increase another 1.2 million barrels per day. This 2016 number has been decreased recently to adjust for possible economic softness in 2016. That forecast reduction, in part, has been taken in response to potentially higher interest rates softening world economies. No, the major culprit here is not demand, it is Saudi Arabia, trying to retain market share, flooding the market with supply, to knock down rapidly rising production in the US. This also works to punish many OPEC rivals, as well as Russia and Iran. Again, this is not a demand slowdown issue. The very low prices are all about an oversupplied market.”
We remained bullish at the time, which proved to be the only major market pullback we’ve seen since then.
In our last post “Strange disconnect … ” we espoused our positive case for higher inflation as a benefit for stocks.
“One of the reasons for the lethargic recovery we have experienced in earnings is the lack of pricing power that the current low-inflation environment has levied on corporations. In a normal environment corporations can raise prices from time to time to compensate for higher costs. Often those price increases cover more than rising costs. When coupled with unit growth and cost efficiencies you have a much more robust earnings growth climate, which, if moderate inflation returns (2.5 to 3%), could provide earnings surprises. Importantly, moderate inflation is not a bad thing for stocks.”
REMEMBER, common stock ownership is a classic hedge against inflation!
So I say make a New Years Resolution to not let the media get you down with talk of burgeoning inflation and higher interest rates. Both in the intermediate-term are good omens for the market! Also, do not fear correction (s) that may be spawned by these fears. My sense is they will be buying opportunities.
What do you think.
The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment strategies or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.