Persistent Inflation Sends Stocks Near Bear Market Levels

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While headline consumer inflation (CPI) readings rose 8.3% year-on-year for August, the improvement was not as much as expected. More importantly, the sticky side of the inflation data remains a major challenge, as discussed last week. The Atlanta Fed’s sticky inflation measure rose year-on-year to 6.1%, a new high for this cycle. This deadly combination sent the shares back to near bear market levels.

As expected, some moderation in the pace of price gains for commodities, particularly energy, helped the correction in the headline.

Unfortunately, some areas of inflation linked to the reopening of the economy after the lockdown were less helpful this month. Even though three out of five CPI readings were below the headline, all five had higher year-on-year price changes compared to the previous month.

As noted last week, a continued decline in the headline inflation rate is a necessary but not sufficient condition for the Fed to deviate from its expected aggressive rate hike path. Rent is an example of sticky inflation that continues the inflation story. Given the resilience of the labor market in the event of a rate hike, there is not much relief on the wage front too soon.

The one-year forward fed funds futures rate is an important variable for recession prospects and Treasury yields. In the wake of consistently high inflation levels, expectations for the fed funds rate hit a new high reading of 4.26% in one year, up from 4.06% in mid-June when stocks bottomed and Treasury yields high. Went. Markets are up at least 75 basis points (0.75%) in Wednesday’s meeting, up 50 basis points in November and at least 25 basis points in December. In addition, 2-year Treasury yields formed a new cycle, while 10-year Treasuries are very close to June highs. The need for a more aggressive rate hiking cycle from the Federal Reserve to deal with the threat of persistent inflation lowers the odds of surviving a recession.

Cyclical stocks, which are more financially sensitive, had started outperforming Staples, but the trend definitely eased after the inflation report. This move reflects the high probability of bearish pricing in stocks.

Value stocks have been the relative beneficiary of higher yields and outperformed again last week. simultaneously, Growth-at-Fair-price (GARP) Stocks with good balance sheets look attractive, combining long-term earnings growth opportunities with low valuations.

The value space also has attractive relative valuations, which, given the history, sell at a very reasonable level relative to growth stocks.

The road for stocks looks set to remain choppy as the market battles rising odds of an economic slowdown due to the Fed raising rates to fight inflation. Investors must have a suitable asset allocation and focus on quality, attractively valued companies to ride through the impending downturn and thrive thereafter. On a more positive note, future stock returns have generally been strong after a 20% drop from a high, and a level stocks are near.

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