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Weekly Report – Should Investors Be Concerned About Equity Market Weakness This Week?

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INSIDE THIS EDITION:

Should Investors Be Concerned About Equity Market Weakness This Week?

You may recall that several weeks ago, we made the bull case for risk assets, including stocks. We provided a myriad of reasons for our bullishness, including what appeared to be the resolution to COVID-19 that would allow an economic rebound to accelerate, a government likely to provide additional stimulus, and robust profit growth heading into the remainder of 2021. Although the last day or two of this week proved to have some volatility, we generally view the pullback as relatively healthy and does not meaningfully change our outlook moving forward.

In fact, we think the pullback over the last several days is healthy and brings forward P/E multiples on major indices like the S&P down.

And we think this is a healthy development, especially as we see in the charts below that when valuation multiples do drift lower, the expected returns for stocks tend to go up. And that is for both short 1-year time frames as well as longer 5-year horizons.

What is driving the recent pullback? We see it as a reaction to inflation concerns and what a bump in inflation could mean for interest rates. After all, periods of inflation are often followed by higher interest rates.

This is in fact one of the reasons we saw bonds decline along with equities and other commodities—higher interest rates tend to put downward pressure on asset prices.

We acknowledge that the unprecedented amount of stimulus and pent-up demand that is likely to flow through the economy once COVID-19 is entirely behind us. This demand might prove inflationary. However, we believe that it is crucial to view inflation through a more nuanced lens that considers not only this short-term inflation picture but also the longer-term inflation possibilities following the global pandemic and the accompanying policy responses.

As we mentioned, we will likely see short-term inflationary pressure rise as we near the end of the global pandemic. This would be triggered by more demand for goods and services or simply “too much money chasing too few goods” as economies fully reopen. This is generally agreed upon as economists have discussed the pent-up demand scenario into the second half of the year.

In the longer-term, however, there is considerably more dissent about inflationary trends. Some believe it is unlikely to materialize, while others believe that a more aggressive inflationary period might lie ahead, necessitating rapid action by the Federal Reserve to contain it.

Our view is somewhere closer to the center, where we believe that the short-term is likely to present higher inflation rates in line with the new Fed policy framework, especially as the post-COVID economy is expected to see demand outstrip supply and cause some transitory inflation pressures to surface. However, this is only the first side of the inflation coin. The other side is in the long-term, and although we see a less clear picture at present, we would argue that inflation in the longer term may increase but be reasonably benign. The reasons are numerous, but more than anything, we see several disinflationary pressures counteracting an upward inflation trend over the long term—more specifically, demographic trends, technological innovation, rising inequality, and higher savings rates. Each of these helps drive prices lower and therefore should help keep inflation in check without triggering the need for rapid interest rate hikes.

If that turns out to be the case, then we think all the concerns shown over the last few days may be overblown, especially when we look at the consumer price index for all urban consumers. By that measure, we are in the range of what we have seen over the last 20 years from an inflation perspective. Even a meaningful increase in this price index might not compare to what we saw during prior inflationary episodes.

At present, we are not too terribly concerned by inflation, interest rate path, or the recent pullback in equities.

However, where things might get a little bit more interesting and would give us more concern is if we get two things to occur—a strong, sustainable upward push on wages and a reversal of the trends we see in money velocity.

As the two charts above show, nominal wage growth continues to be well below target, and M2 money supply remains low. This leads us to believe that for now, some of the concerns driving markets might be premature. However, if wages start to move significantly higher and money velocity picks up considerably, the Fed could get substantially more hawkish, and markets could see more downside volatility. 

Weekly Global Asset Class Performance Table





Disclaimer:

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, referred to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives to review/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

Financial Planning and Investment Advice offered through STA Wealth Management (STA), a registered investment advisor. STA does not provide tax or legal advice and the information presented here is not specific to any individual’s circumstances. To the extent that this material concerns tax matters or legal issues, it is not intended or written to be used, and cannot be used, by a taxpayer to avoid penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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