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Inside The Broker

Inflation fears rock stock indices


Inside the Broker

Inflation fears rock stock indices

At the end of October last year, the S&P 500 briefly dipped below 3,250 before it shot higher. Since then, the index hasn’t come close to retesting that October low. But there have been a few significant dips since then. At least, that’s what it looks like on the chart, although a closer analysis suggests that these proved to be mere hiccups on the route to current levels.

Surprise jump

But that bit of hindsight aside, last week investors rushed for the smelling salts and the exits as US and European stock indices slumped. The sell-off was blamed on a sharp spike in inflation as measured by the US CPI on Wednesday. Headline CPI surged by 4.2% compared to the same period last year, more than double the US Federal Reserve’s preferred target rate of 2%, and the fastest increase in inflation since 2008. It rattled investors enough to send global equity prices tumbling back through a stack of significant support levels in a frighteningly fast move, led by US tech shares. But US equities were already in decline having fallen on both Monday and Tuesday following a record close-out for both the Dow and the S&P at the end of the previous week. In fact, Wall Street was looking rather overbought, following on from the first quarter earnings season where most US corporations handily beat consensus expectations on both earnings and revenues.

Stimuli, stimuli everywhere

Last week’s move looks like a much-needed cull of late buyers which flushed out the weakest hands. Sure, the inflation numbers came in much higher than expected, and it’s fair to say that the response to the global pandemic, following lockdowns, has been to hose monetary and fiscal stimuli at the problem. In response to the Great Financial Crisis of 2008/9 when central banks slashed their headline interest rates to zero and beyond, while buying up bonds and, in some cases, equities, inflation has barely stirred. This is a problem for the global financial system given the mountain of debt it stands on. ‘Modest’ inflation is seen as the most painless way to eliminate debt, certainly less painful than defaulting, or horror of horrors, paying it back. For well over a decade, the heads of all the world’s major central banks have been begging governments not to rely on monetary stimulus to rescue the global economy. They have repeatedly asked governments to ‘do their share’ and start spending. Most were reluctant, either because they feared being viewed as profligate and irresponsible by voters, or, as in the case of the EU, rules forbade such action. Now, thanks to the coronavirus pandemic, the central bankers have got their wish. Fiscal stimulus is everywhere, with the Biden Administration leading the way with its plan to spend $6 trillion over the next ten years.

Pandemic fears subside

But as vaccination programmes have kicked in and appear to be extremely effective in halting the spread of the virus, the global economy is opening again. Now investors worry that all this stimulus will trigger a burst of inflation that could itself threaten recovery as interest rates are raised in response. But the Federal Reserve has repeatedly said that any pick-up in inflation this year would, in its view, be transitory, and due to ‘base’ effects – that is, comparing today’s recovery with the enormous deflationary slump we were going through due to last year’s global lockdown. On top of this, Chairman Powell and his colleagues have made it crystal clear that they’re happy to see inflation go above its 2% target for a significant period before they start to tighten monetary policy.

A daily chart of the US S&P 500 showing the four pull-backs that have taken place so far this year

Panic over? Maybe. Let’s consider the S&P chart and try to put last week’s sell-off into perspective. So far this year we’ve seen four ‘significant’ pull-backs in the S&P 500. The first came at the end of January when the index fell 2.2% in a week. The second began in mid-February and lasted three weeks for a loss of 4.7%. The third happened in March and lasted seven days for an overall loss of 2%. Last week the S&P 500 fell 4% in four days. For further context, on Thursday the S&P had a low-to-high range of 2.5%, easily outscoring the whole of the downturns in January and March. No wonder there was a feeling of panic. Traders had forgotten what a profit-taking sell-off looks like.

Smart News and our Dashboard

We’ve been analysing our Smart News social media widget over this period. Given what was going on in the underlying market, we expected ‘inflation’ to be easily the most-mentioned term, closely followed by ‘bubble bursting’ and ‘bear market’. How wrong could we be. Our dashboard showed that ‘Coronavirus’ was easily the most-mentioned topic, followed at some distance by Bitcoin. Pfizer was also in the top ten. Now, this could be due to the terrible news coming from India, but it’s just as likely to be chatter about countries easing lockdown restrictions due to successful vaccination programmes. This is a positive story underpinning equity markets which is supported by the big gains made by so-called ‘recovery stocks’ such as airlines, cruise companies and other travel operators.

You can follow everything that’s finance-related in social media by clicking on to our Smart News widget. You’ll find the button on the bottom-right of our trading platform when you log in to the Trade Nation live account. Here you can launch feeds that we’ve created or put your own together based on your favourite watchlists. Smart News really can help you stay ahead of market-moving events.


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