Inflation fears are stoking volatility in stocks but they’re unlikely to derail the market rally, says UBS

NYSE traders
  • A jump in US inflation will stoke bouts of volatility in the stock market but it’s not likely to stop the overall rally, says UBS.
  • Consumer price inflation for April soared by more than expected, to a rate of 4.2%.
  • “We think that the reflation trade has further to run, UBS said Thursday.
  • See more stories on Insider’s business page.

US inflation rates are flying up and worries about an acceleration in prices ranging from airline tickets to energy have knocked stocks off their record highs, but those fears are unlikely to derail the overall rally in equities, wealth manager UBS said Thursday.

The “latest volatility does not come as a surprise. But we also don’t see it as signaling an end to the bull market,” Mark Haefele, chief investment officer of global wealth management at UBS, wrote to clients.

The arrival of April’s Consumer Price Index confirmed months of caution from economists who said stronger inflation was on the way, a reflection of ongoing economic recovery from the COVID-19 pandemic. The higher-than-expected headline and core inflation readings drove stocks sharply lower Wednesday.

Market pricing of the inflation outlook also stepped higher, said UBS, noting the US 10-year breakeven rate moved to imply an average inflation rate of 2.56%, close to the highest level since 2013 and up from 2% when 2021 got underway.

The CPI data triggered Wednesday’s selloff in stocks that left the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average each down by at least 2%, with the Dow industrials tumbling 682 points.

“The latest rise in inflation, in our view, reflects year-over-year comparisons, which will fade,” he said. “While raw material prices may climb further, we believe the bulk of the rise in commodity prices is now over. In addition, labor supply headwinds should ease in the next few months once schools fully reopen, vaccinations continue to rise, and supplemental unemployment benefits expire.”

The CPI jumped to 4.2% from a year earlier, the largest increase since 2008, and core inflation, which strips out volatile energy and food prices, surged 0.9%, the largest one-month climb since 1982.

The UBS wealth management chief said it was important to note that major central banks have indicated they will not tighten policy in response to a temporary increase in prices. He outpointed that Federal Reserve Governor Lael Brainard said Tuesday the Fed will be “patient” as an inflation surge looks transitory.

“As inflation uncertainty persists, and as economic reopening remains on track, we think that the reflation trade has further to run. Our preferences include small-caps, financials, energy stocks, commodities, and emerging markets,” said Haefele.

Investors on Thursday appeared to set aside inflation worries, with Wall Street’s key stock indexes riding up roughly 1% each after weekly jobless claims hit another pandemic-era low.

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The 10-year Treasury yield has jumped to its highest in 14 months, cutting further into gains for growth stocks

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Federal Reserve Chairman Jerome Powell.

  • Borrowing costs are rising as implied by the benchmark 10-year Treasury yield, which hit its highest since January 2020.
  • Tech stocks fell as the yield pushed past 1.6%, drawing the Nasdaq Composite down 1% during Wednesday’s trading session.
  • The Fed would likely spring into action if the 10-year yield were to hit 2% by the end of March, says one analyst.
  • See more stories on Insider’s business page.

Borrowing costs as tracked by the 10-year Treasury note yield rose to their highest in 14 months on Wednesday, with investors pricing in expectations of hotter inflation while they cut down high-flying growth stocks.

The yield on the benchmark 10-year Treasury note hit 1.67%, a level not seen since mid-January 2020, before the COVID-19 outbreak was declared a pandemic and before it had accelerated in the US. Yields rise as bond prices drop.

The yield has quickly pushed higher since the start of 2021, from around 0.9%, bolstered by improvement in the world’s largest economy after it and other economies worldwide fell into recession last year.

“What the market is trying to price in is a much more optimistic Fed … that is likely to remain committed to providing more accommodation into this economic recovery,” Ed Moya, senior market analyst at Oanda, told Insider on Wednesday before the release of the Federal Reserve’s economic projections and monetary policy decision at 2 p.m. Eastern.

Along with growth, investors also expect inflation to increase and for the Fed to begin raising interest rates after they slashed them to near zero in March 2020 in response to the health crisis.

The step-up in the 10-year yield, which is tied to a range of lending programs including mortgages, has spurred a pullback in growth stocks, notably large-cap tech stocks, and a rotation into cyclical stocks set to benefit when an economy improves.

Those moves showed up Wednesday with the tech-concentrated Nasdaq Composite falling by 1.1% and the S&P 500‘s information technology sector losing 1.3%. Shares of Apple dropped by 2.2%, Google’s parent company Alphabet declined 1.7% and Microsoft gave up 0.8%.

“You’re probably going to see that the Fed is still going to be stubborn as far as when that first rate hike is going to happen, but the markets are just going to go ahead and price that in a lot sooner,” said Moya.

There are market expectations that the Fed will begin raising its fed funds target rate in 2023 from the current range of zero to 0.25%. Meanwhile, more fund managers now consider higher-than-expected inflation would be the biggest danger to the market, replacing COVID-19 as the main risk, according to a Bank of America survey for March.

The US economy is expected to recover further with the US government circulating COVID-19 vaccines from three companies — Pfizer and its partner BioNTech, Moderna, and Johnson & Johnson — and with about 111 million people already vaccinated.

“Also, it doesn’t hurt when you have almost $2 trillion in [fiscal] stimulus get done since your last policy meeting,” said Moya, adding that “the economy is likely to run hot for a little bit.”

A steady grind higher of the 10-year yield “is completely healthy,” said Moya.

“But if this pace continues [and] by the end of the month we’re above 2%, that is going to be somewhat disruptive to the economic recovery,” which would likely prompt the Fed to take action, he said. The Fed’s tools include buying more Treasury bonds, he added.

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The post-pandemic economy will see a new class of growth stocks emerge, Fundstrat’s Tom Lee says

Thanksgiving airport coronavirus
Travelers wearing protective face masks walking through Concourse D at the Miami International Airport on Sunday, November 22, 2020 in Miami, Florida.


As the economy climbs out of the pandemic, a new class of stocks could emerge as investors’ go-to for growth: cyclical stocks.

That’s according to Tom Lee, who is anticipating that after a year where growth was dominated by technology and stay-at-home plays, stocks that hinge on an economic recovery have the most upside in 2021.

The Fundstrat head of research said that in 2021, Americans will shift away from their “digital life” and back to an “analog life.” While the COVID-19 pandemic was similar to a wartime economy, 2021 will be a post-war period, with a focus on rebuilding, and the stimulus bill approved by the House on Wednesday will further solidify these changes, Lee said.

Businesses will reopen, US households will receive substantial relief from the incoming stimulus package, and infrastructure spending will increase.

All of these changes will likely change the “psychology of investors,” Lee explained. If theme parks are booming, no one will want to buy Netflix, and if people are taking their first trip in a year, they won’t be thinking about buying Zoom.

In the post-pandemic economy, cyclical stocks, those that gain when the economy expands, will be the new “growth stocks.”

“After any war, cyclical companies become growth companies as economies are rebuilt. This is why cyclicals, in our view, are taking leadership,” said Lee.

Lee introduced a “Power Epicenter Trifecta” list to identify the cyclical stocks with the strongest price appreciation potential.

Some names on the list include travel stocks Norwegian Cruise Lines and Royal Caribbean, Delta Airlines, energy stocks like Exxon Mobil and Schlumberger, and even office REITs Boston Properties Inc and Highwoods Properties Inc.

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