Uncategorized, Weekly Update

The Market Needs Inflation

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Published November 15, 2019


We are shaped by the financial crises we experience. For those of us who lived through the sharp inflation hike of the 1970s, we are forever sensitive to inflation, looking behind every datapoint for evidence of the inflation beast lurking. Over the past decade, inflation has been remarkably steady with the inflation beast long ago tamed.

Steady inflation the last decade

While talking about inflation, we must remind ourselves that the inflation data reported is an average based on certain categories of spending. In reality, for each of us, our own personal inflation experience can be wildly higher or lower than those averages. For example, if you rent in a city where housing supply is tight, you are substantially exposed to increases in rent; housing cost and related inflation is a big deal for you. Quite the opposite if you are retired and own your home. However, retirees might be more exposed to the rising costs of healthcare. Parents of teenagers are potentially exposed to the sharp increases in education cost. And so it goes, each of us sensitive to our own inflation drivers.

As interest rates incorporate inflation expectations, interest rates have slid sharply as inflation has come back down. As the chart below shows, interest rates peaked in 1981. They’ve been tumbling ever since – a nearly 40 year bull market in bonds has been the result.

Interest rates peaked in 1981

Interest rates less inflation – so-called “real” interest rates – have gone negative off-and-on over the past six years. Without a new emergence of inflation, negative interest rates are likely to be here to stay.

Policy-makers want inflation at this point, but struggle to get it with global economies stagnant. At this point, markets need inflation to push money out of bonds and into stocks. Interest rates are so low that stocks should be able to handle a substantial move in rates before encountering any real trouble.

Market Update

Markets continued to be influenced by trade talk this week while also reflecting on the recent earnings season, which has generally come in better than expected. The offsetting influence of increasingly violent demonstrations in Hong Kong and the largest ever Singles Day sales by Chinese giant Alibaba (BABA) kept stocks in check Monday with a -0.2% finish. Tuesday brought a flat trading session with investors focused on President Trump’s speech to the Economic Club of New York. Another largely unchanged trading effort Wednesday with Disney (DIS) spiking higher on positive news regarding their just released streaming service. Additional positive earnings news Thursday from Walmart (WMT) supported stocks. However, that good news was offset by a negative report from tech heavyweight Cisco Systems (CSCO). While the market was treading water and closing around breakeven throughout the first four days of the week, we should point out that buying was evident as every single market dip was met with buying. That trend finally led to higher prices in Friday’s session with stocks rising +0.8% on the back of a strong rally in healthcare stocks. A Trump Administration plan forcing insurers and hospitals to display more pricing cheered investors as the plan was actually viewed as more favorable to the companies than expected.

The stock market continued to push upward, hitting new record highs on a regular basis as near-term recession fears subside. The S&P 500 (SPY) rose above 3100 this week on a +0.92% rise, it’s sixth consecutive weekly lift. The Nasdaq 100 (QQQ) added +0.83%. The small-cap Russell 2000 (IWM) ran into resistance at the top of its year-long trading channel, ending the week unchanged with a -0.10% move.

Warm wishes and until next week.