Traders confront inflation’s reality

All 11 industries in the S&P 500 tumbled, a coordinated plunge that hadn’t happened since the run-up to Trump’s election


NEW YORKFor almost a decade, investors have waited patiently for any hint of inflation in the US economy, a sign the recovery can sustain itself without emergency stimulus from the Federal Reserve (Fed). Now they’re getting it, and many are shocked at the reaction.

It landed last week with the worst stock market plunge since January 2016. A stronger than expected employment report with signs of strengthening wage growth sent the Dow Jones Industrial Average down 666 points last Friday, bringing its five-day loss to almost 1,100 points. Share volatility surged.

Accounts of how concerned investors should be ran the gamut, from confidence traders will rush in and buy the dip, to warnings this time is different — that sell-offs that begin in the bond market have a habit of snowballing.

“It is now signalling, potentially, the end of this eight-year bull rally,” said Rich Weiss, CIO and senior portfolio manager of multi-asset strategies at American Century Investments. The firm manages US$179 billion (RM695.77 billion). “The Fed is going to have to move the interest rates, the bond market is recognising that this incremental economic growth will spur on inflation from various sources.”

Little escaped the sell-off. All 11 industries in the S&P 500 tumbled, a coordinated plunge that hadn’t happened since the run-up to Donald Trump’s election. Yields on 10-year Treasuries surged as much as six basis points last Friday to 2.85%, the highest in four years. Oil dropped and the Bloomberg Commodity Index capped its biggest weekly slide in two months.

Of all the threats, surging Treasury rates and their implications for inflation are vexing investors the most, with this year’s half-percentage-point climb calling into question a valuation case on equities tied to how much more you get from corporate earnings than in bond interest.

For last week, anyway, nobody seemed to care about the ostensibly positive signals coming from the bond market, the idea that higher yields bespeak rising demand for money among borrowers.

“It’s kind of a strange time and we seem to be driven by a fear of what everyone wants, and that’s higher rates,” said Joe “JJ” Kinahan, the chief market strategist at TD Ameritrade. “Higher rates confirm a stronger economy, and the market was very afraid of that all week long. And that’s been a big reason for selling.”

An irony for bulls is that the sell-off arrived amid one of the best rounds of corporate earnings upgrades ever seen in the S&P 500. Combined estimates for 2018 profits among companies in the index have gone from US$145.90 a share on Dec 15 to US$156.20 last Friday, a rate of increase that is four times faster than any stretch since at least 2012, data compiled by Bloomberg show.

In theory, the increase should help assuage fear bred by charts of the US stock market’s price-earnings ratio. Using profits from the last 12 months, companies in the S&P 500 are trading for 22.5 times income, a level that since the dot-com bubble burst is matched only during the aftermath of the financial crisis, when earnings were close to nothing.

Central to the current anxiety is how far stocks have come in so short a time. Last month’s 5.6% gain in the S&P 500 was the biggest for any January since 1997, and using the index’s total return it has now risen for 15 straight months. Last Friday’s sell-off finally ended a streak of 404 days in which the S&P 500 sailed along without a 3% decline from any previous point, a record in data going all the way back to 1928.

Michael Purves, Weeden & Co’s chief global strategist, said investors should get used to turbulence given the strength of the market’s run-up. But it shouldn’t derail a bull market that is seven months away from becoming the longest ever.

“I’ll bet you a bag of donuts that by Wednesday or Thursday of this week the equity market starts finding its footing against the backdrop of more stable bond yields,” Purves said. “And then, like any bottoming process, the market tests it and tests it again and then all of a sudden, boom, new buyers come in.”

“The overall complexion here is that earnings have been pretty robust, economic data is holding together well, inflation is starting to pick up — there’s nothing really different in terms of an overall bull trend,” he said. — Bloomberg