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

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  • 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 S&P 500 has rebounded 76% since its lowest point in the pandemic crash one year ago today. 2 experts unpack an unprecedented year filled with virus-driven volatility.

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  • The S&P 500 reached its lowest point in the coronavirus-induced market crash exactly one year ago today.
  • Insider spoke with two experts to unpack a volatile year that saw the benchmark index swiftly rebound to new record highs.
  • The analysts say Fed policy and stimulus drove the market rally, but those factors also contributed to investor speculation in 2020.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

One year ago today, the S&P 500 reached its lowest point in the coronavirus-induced market crash. The benchmark index bottomed out at 2,237 on March 23, 2020, following some of the largest down days in market history.

On March 16, the S&P 500 dropped 12%, the same day the stock market’s “fear gauge,” -the Cboe VIX volatility index- closed at a record high. Insider spoke with two analysts to unpack a rollercoaster year for financial markets.

“There was almost a sense of numbness to the continued volatility, but because of the uniqueness of the crisis, there was also a real sense of ‘how low can we go?'” said Ross Mayfield, a Baird investment strategy analyst. “It was also coupled with the panic in the real world – grocery shelves were ransacked, the streets were empty, and there was a real fear amongst most people I talked to.”

Megan Horneman, director of portfolio strategy of Verdence Capital Advisors, said her team tried to focus on the buying opportunity presented instead of worrying about the collapse of the financial markets at the height of the crash last year.

“We added equity exposure and credit exposure throughout March 2020 because we knew the government would be pumping trillions of dollars into the economy to get us through the self-inflicted recession,” she told Insider.

Unprecedented fiscal and monetary relief in March 2020 saved the “health crisis from becoming a financial crisis,” Mayfield said. At the height of the market panic, the Federal Reserve enacted an emergency rate cut, dropping its benchmark index rate to zero while launching a $700 billion asset purchase program. Meanwhile, Congress passed the $2.2 trillion pandemic relief stimulus, the CARES Act.

By early June, the S&P 500 was back within a few percentage points of all-time highs.

“The surprise was in the strength of the rebound,” Mayfield said. “Almost everyone figured it had to crash again or retest the lows, and it just never did (even as the pandemic worsened into the summer).”

While the S&P 500 saw a healthy rebound, investors also began to pour their cash into more speculative assets. Horneman said one of the most surprising parts of the market rebound was witnessing how “massive liquidity can fuel speculation.” She cited the GameStop rally and bitcoin’s nearly 800% run-up as two examples of cash-fueled investors stepping out further on the risk curve in 2020.

Horneman has now seen a shift in market sentiment. While the initial rebound was driven by low rates and stimulus, now stocks have been guided by optimism around the rollout of the vaccine and reopening of the economy. This can be seen by the rotation from stay-at-home tech stocks into stocks that hinge on a reopening, like travel and entertainment names.

The S&P 500 has now gained 76% since its lowest point one year ago. The analysts expect the next leg of the rally to continue to be supported by stimulus and accommodative policy from the Fed, but they also see economic growth driving the market higher.

“In the end the most supportive factor will be the reopening of the global economy. We have the cure, the vaccine,” said Horneman.” Once we can reopen the global economy we will be left with massive stimulus, healthy corporate and consumer balance sheets and substantial pent up demand. This should lead to a multi-year acceleration in economic growth.”

Read the original article on Business Insider