2021 is a ‘turning point’ for inflation and stock investors should anticipate lower long-term returns as a result, Bank of America says

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  • Bank of America sees 2021 as a “turning point” for inflation that could weigh on stock returns.
  • An economic re-opening, $1.9 trillion stimulus, and vaccine rollout could push up inflation.
  • The firm is bullish on value stocks, cyclicals, commodities and real assets against this backdrop.
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The lower inflation of the last 40 years that sent interest rates down and stock market valuations higher has reached a turning point, according to Bank of America’s chief investment strategist Michael Hartnett.

“We believe we are at a secular turning point for both inflation & interest rates,” Hartnett and a team of Bofa strategists said in a note Thursday. “We believe 2020 likely marked a secular low point for inflation and interest rates due to a reversal of deflationary secular factors, fiscal excess, and an explosive cyclical reopening of the global economy creating excess demand for goods, services and labor.”

Now, as the economy reopens, vaccine rollout speeds up, and Washington’s $1.9 trillion stimulus bill is signed into law, the US could see a jump in inflation, according to the bank.

That jump could impact long-term equity returns. Stock investors who’ve seen a roughly 10% annual return from recent decades should expect that gain to go down to 3%-5% over the course of this decade, said BofA.

The firm recommends US stock investors focus on value stocks and cyclical stocks against this backdrop. Energy and Materials are the two sectors most levered to inflation, they added. Meanwhile, investors should “be nimble” around secular losers like oil, brick-and-mortar retail, and other areas that are likely to face continued disruption.

They noted it’s too early to price in if and when we’ll see a “disorderly jump in inflation and yields.” However, signs that typically precede inflation spikes are showing: 2021 has been the 4th worst start for the 30-year Treasury in the past 100 years, and the best start for oil since 1974.

“We believe the long-term asset allocation implications of 2020s inflation are bullish real assets, commodities, volatility, small cap, value & EAFE/EM stocks, and bearish bonds, US dollar, large cap growth,” said BofA.

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Fears of inflation are overblown, but it could still trigger near-term stock market volatility, UBS says

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UBS’s chief investment officer of global wealth management says investors should brace for a near-term spike in inflation, but concerns about a long-term rise are overblown.

“…While we think inflation may spike in the near term as pent-up demand meets constrained supply, we believe fears about a persistent rise are likely to prove overdone. However, such concerns could still trigger bouts of market volatility-S&P 500 futures were down 0.7% on Monday-and may test investors’ resolve,” said Mark Haefele in a Monday note to clients. 

The CIO recommends to investors to “keep going cyclical for the recovery,” against this volatile backdrop. Cyclical stocks are those that react positively when the broader economy improves. UBS favors small-and mid-cap stocks globally and US large-cap stocks in financials, energy, industrials, consumer discretionary, and healthcare.

With COVID-19 cases and hospitalizations declining in the US and vaccinations on pace for roughly 2 million shots a day, Haefele expects a wider opening of the US economy in the second quarter of 2021. Congress will likely pass a relief package north of $1.5 trillion before the end of March and the Fed will remain accommodative. Additionally, S&P 500 companies’  fourth quarter earnings exceeded expectations by almost 20%. This should be a positive environment for the cyclical rotation to continue, Haefele said. 

Investors concerned about an uptick in US inflation will be watching the Personal Consumption Expenditures (PCE) price index for January that will be released Friday. 

Meanwhile, UBS economists forecast that while the stimulus out of Washington may be larger than necessary, the package’s effect on inflation “likely will be small.”

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