(Bloomberg Opinion) — Call them cheeky, call them clever, but stock investors show no signs of being intimidated by the highest inflation in decades or the accompanying rise in bond yields.
His boldness has sent analysts searching for ways to explain how the S&P 500 Index has managed to rally in five of the last six sessions, including as the Federal Reserve promises higher rates, the war rages in Europe and Treasury rates experience the largest two-day increase in two years.
One theory gaining traction is that stocks are among the best assets to hold when consumer prices soar.
“In inflationary environments, stocks have a clear advantage over bonds, they are linked to companies that can adjust prices, while bonds not so much,” said Lawrence Creatura, a fund manager at PRSPCTV Capital LLC. “Companies, on the other hand, can raise prices and you just have to go to your local 7-Eleven to see it.”
The S&P 500 was up 1.1% on Tuesday, led by the consumer discretionary and communications sectors. Meanwhile, the slide in US Treasuries deepened after Federal Reserve Bank of St. Louis President James Bullard told Bloomberg News that monetary policy needs to be tightened to curb inflation, reiterating his call for interest rate hikes to exceed 3% this year. That came a day after central bank Chairman Jerome Powell said the Fed would not rule out raising rates by half a point at its May meeting.
Between Powell and Bullard, the fixed-income market is starting to believe that a 50 basis point hike isn’t a baseless threat, said Ellen Hazen, chief market strategist and portfolio manager at FL Putnam. Meanwhile, “the stock market is telling us that the economy is not going to be hurt by these higher rates,” she said by phone.
A look back at the inflationary period of the 1970s and early 1980s gives clues to the divergence. Nicholas Colas, co-founder of DataTrek Research, examines the inflation for the 159% duration of this period, and calculates the value of the life of the hall in the same amount. However, the S&P 500 increased an Aggregate Return of 169%, showing that earnings can keep pace with inflation even if macroeconomic growth slows, he said.
“As much as equity markets may not like it in the short term, seeing 10-year yields improve going higher would be a very healthy long-term signal about the state of the US economy,” he said.
Certainly there are other forces helping to drive market optimism, from strong manufacturing data to robust hiring and the subsequent lifting of covid-imposed restrictions.
And then there’s the bull case that has held up during this year’s market turbulence: the resilience of corporate America. After weathering inflation and posting record profits in 2021, S&P 500 companies are expected to deliver another year of earnings expansion, thanks to their ability to pass costs on to customers. Over the past month, analysts have increased their 2022 event estimates by more than 1% to $225.70 a share, data compiled by Bloomberg Intelligence shows.
Stocks as an inflation hedge is a new general narrative for a rally
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