Inflation—economy-wide price increases—can take a toll, particularly for households on a fixed budget. This is likely, in part, why data releases like last Thursday’s January US Consumer Price Index showing prices rose 7.5% y/y spurred many warnings from commentators we follow.[i] Adding to the gloom, inflation has become increasingly politicised—on both sides of the Atlantic—which can make it difficult for investors to weigh its market impact, in our view. That is what we focus on, so what follows isn’t an ideological or political statement, but rather, something we think all investors benefit from keeping in mind: For markets, we don’t think the most relevant question is about when inflation moderates, how high it peaks or how monetary authorities respond. Rather, the critical issue to remember is that stocks price in all widely known information, including widely held expectations, based on our research. Seen in that light (and notwithstanding recent volatility), we think the vast, vast attention paid to rising inflation rates should help stocks: It further saps the shock factor, likely allowing markets to move on sooner than many commentators we follow seem to expect.
In our experience, volatility and widespread, frightening headlines often move together—and follow a recurrent pattern. It usually goes something like this:
We don’t think this is a conscious realisation, mind you. We find it is more of an extension of confirmation bias, a behavioural tendency for people to latch on to information that conforms to their preconceived notions whilst dismissing contrary evidence: The person hearing warnings that X would happen then saw X happen and markets wobbled. In our experience, people tend to see this as validation, even if the wobbles weren’t big or lasting.
Take 2015, a rocky year amidst a decade-plus bull market (extended period of broadly rising stocks).[ii] Then, warnings amongst commentators we followed rotated around a Chinese economic slowdown and another Greek default. Chinese growth actually slowed![iii] Greece defaulted for the third time in four years![iv] The MSCI World Index fell -11.1% from 10 to 25 August, then floundered through September.[v] But by that October’s close, stocks had moved back near pre-correction levels.[vi] Some commentators we follow continued sounding the alarm about China and Greece—but these situations’ ability to shock was drained, in our view. We think people saw the alarming thing happening and driving a correction. Consciously or not, we suspect they realised its power was spent. We observed stocks repeat that very feat at that yearend, when long-lingering warnings of a US Federal Reserve (Fed) rate hike from commentators we follow finally materialised in December.[vii] Volatility ensued, but it was over in weeks—and stocks rebounded swiftly.[viii]
We think this is starting to happen with inflation. Stocks’ volatility since January has commentators we follow sounding the alarm even louder. Thursday and Friday’s -3.2% MSCI World Index drop is seemingly a case in point.[ix] The US 10-year Treasury yield’s rise to just over 2%—with headlines we follow proclaiming it the highest since 2019—is another prime example, in our view.[x] Such headlines seem to us so focused on near-term swings that they forget 2% is about where American long-term rates were just before the pandemic—a low level by historical standards.[xi]
Markets are now pricing in a probable 50 basis point (half percentage point) Fed rate hike in March and several more after as monetary policymakers try to get prices in check.[xii] We have noted before the Fed’s inability to address supply issues behind price increases—in our view, rate hikes won’t magically multiply primary residences to rent or own, fabricate semiconductors, build autos or refine more oil. Yet commentators we follow now claim demand is too high and must be reined in.[xiii] Whilst we think that is misguided, the hype is allowing markets to pre-price this. A similar phenomenon surrounds the heightened expectations for the Bank of England (BoE) to raise rates aggressively this year, in our view.
With more and more commentators we follow expecting a 50 basis point Fed move, it is less and less likely to matter much to markets when and if it comes, in our view. Ditto for the BoE. We don’t think that precludes short-term volatility when monetary policymakers act, but it does perhaps set up a scenario where—once again—people build up fear of a thing, the thing happens, and then the fear loses its power.
Of course, fears may weigh on sentiment and spur short-term volatility, but our research shows what matters for markets longer term is how the expectations markets pre-priced square with reality. Are inflation and steep rate hikes great? Few commentators we follow think so. But neither one is automatically bearish, according to our historical analysis. We also don’t think they are catching anyone off guard. Surprises are what move markets most over time, in our experience. At this point, what negative scenarios are out there that markets haven’t already sorted through?
[i] Source: US Bureau of Labor Statistics, 10/2/2022. US Consumer Price Index, January 2022. The Consumer Price Index is a government-produced measure of goods and services prices across the broad economy.
[ii] Source: FactSet, as of 10/2/2022. Statement based on MSCI World Index returns with net dividends, 9/3/2009 – 20/2/2020.
[iii] Source: FactSet, as of 10/2/2022. China GDP, Q4 2014 – Q4 2015.
[iv] “Greece Defaults on $1.7 Billion IMF Payment,” Virginia Harrison and Chris Liakos, CNN, 30/6/2015
[v] Source: FactSet, as of 10/2/2022. Statement based on MSCI World Index returns with net dividends, 10/8/2015 – 25/8/2015.
[vi] Ibid. Statement based on MSCI World Index returns with net dividends, 25/8/2015 – 31/10/2015.
[vii] Source: US Federal Reserve, as of 10/2/2022. Fed-funds target rate, 16/12/2015.
[viii] Source: FactSet, as of 10/2/2022. Statement based on MSCI World Index returns with net dividends, 30/11/2015 – 31/12/2015.
[ix] Ibid. MSCI World Index returns with net dividends, 10/2/2022 – 11/2/2022.
[x] Ibid. US 10-year Treasury yield, 10/2/2022.
[xi] Ibid. US 10-year Treasury yield, 30/7/2019.
[xii] “Inflation Surges 7.5% on an Annual Basis, Even More Than Expected and Highest Since 1982,” Jeff Cox, CNBC, 10/2/2022.
[xiii] “10-Year Treasury Yield Tops 2% for the First Time Since 2019 After Hot Inflation,” Yun Li and Vicky McKeever, CNBC, 10/2/2022.
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