High inflation not factored in
The S&P 500 fell more than 4 percent on Tuesday as US Consumer Price Index CPI came in slightly higher than expected, causing the market to quickly sell off on concerns about continued high interest rate hikes. Soon the market began to speculate whether the expected 75bp hike at the end of September will be 100bp instead, which could lead to a relief rally on September 27 if the Federal Reserve only hikes 75bp.
Regardless of how much the Federal Reserve
chooses to raise interest rates in a couple of weeks, the crash last Tuesday
showed that the market had not at all priced in continued high inflation, but
that it believed that the war against high inflation had already been won.
It is very possible that we have passed "peak inflation" for this time, but that does not have to mean that we are back at old levels around 2 percent in 12-18 months as the Federal Reserve and other central banks previously predicted, without us entering an era of higher normalized inflation along with higher interest rates.
The last time we saw inflation as high as today was over 40 years ago, when the US CPI during the 1970s rose to over 13 percent at the most, it was primarily commodities that performed best for an entire decade. Between 1970 and 1981, when then-Fed Chairman Paul Volcker finally got hold of inflation by raising interest rates to 20 percent, the broad commodity index S&P GSCI rose more than 700 percent before the sharp hike in interest rates drove down commodity prices. During the same ten-year period, the S&P 500 alone rose just over 40 percent.
US inflation and performance of asset classes (in USD) 1970 - 1982
Note: Historical returns are not a reliable indicator of future returns
US inflation and performance of asset classes (in USD) 1970 - 2022
Above: Indices in USD
In other words, high inflation has meant no
excess return from shares.
Fast forward to today, and we see time and time again how the market does not take high inflation into account. Every time the CPI comes in a little higher than expected, the stock market turns downwards. Since inflation bottomed out after the covid crash in June 2020, US CPI has skyrocketed from almost 0 percent to today's 8.3 percent. During the same period, the broad commodity index S&P GSCI has risen over 100 percent, while the stock index S&P 500, after a broad rise of 50 percent, has since fallen back and is now up a total of about 25 percent during the same period.
So far, it has mainly been rising energy prices that have driven inflation, but in the latest figures, food and housing lead the development of the CPI. It is impossible to say what the future will look like, but the most likely scenario in the coming months is continued rising interest rates and falling stock prices until the Federal Reserve makes a pivot and pauses its interest rate cycle.
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