Strategists still don't think inflation is a problem for stocks

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Monday, June 14, 2021

This is not the 1970s.

Readers already know: Inflation is running hot

But Wall Street strategists still remain largely unbothered by the recent acceleration in prices. And financial markets — at least for the moment — agree. 

As Yahoo Finance's Brian Cheung noted last week, yields on longer-dated U.S. Treasuries fell to multi-month lows as data showed prices in May rose at the fastest pace in decades. At Friday's close, the 10-year yield was sitting near 1.46%, the lowest since early March. The S&P 500 also closed at a record high on Friday. 

And in a note to clients published Friday, Franziska Palmas at Capital Economics argued the present bout of U.S. inflation will not derail the stock market, even though the firm sees inflationary pressures as a bit more potent than the Fed's "transitory" argument might suggest. 

"Our view that inflation in the U.S. will prove persistent is a reason why we forecast gains in the S&P 500 over the next few years to be small," Palmas wrote. However, "we are not anticipating a repeat of the sharp sell-offs seen during the periods of high inflation in the 1960s and 1970s."

Stock prices are, in general, shaped by two trends: Monetary policy and the economic cycle. All else being equal, easier monetary policy and a growing economy are good for stocks; the inverse — as was seen with "stagflation" in the 1970s — is more challenging. 

Right now, both monetary policy and the economic cycle are working in the stock market's favor. And Palmas doesn't see these conditions changing drastically in the years ahead. 

"Signs of rising inflation have not sparked a reassessment of the outlook for monetary policy," Palmas noted. "This is largely because the Fed has stressed that it thinks this increase in inflation will be transitory and that it therefore won’t act on it. Investors seem to believe this: they have not priced in more aggressive tightening even beyond the next few years."

On Wednesday, the Fed will announce its latest policy decision, and publish an updated set of economic projections. Economists expect the Fed to reiterate that it will look past recent inflation data, and remain cautious in pulling back from its asset purchase program.

Palmas also notes that "rising prices and shortages haven’t raised significant concerns about the economic recovery among investors so far. S&P 500 earnings forecasts for the next few years have continued to be revised up."

Earnings estimates for this year, next year, and 2023 continue to climb, a positive backdrop for the stock market. (Source: Refinitiv, Capital Economics)
Earnings estimates for this year, next year, and 2023 continue to climb, a positive backdrop for the stock market. (Source: Refinitiv, Capital Economics)

As we've written about extensively in The Morning Brief, the current challenges in the economy are about demand outpacing supply. 

There are too many businesses that want to hire workers, and too many consumers that want to travel, buy cars and homes, or just go out to dinner

We're still in the thick of the "not enough" recovery, and while there are challenges facing the economy today, most of them can be classified as good problems to have.

And good problems should be good for stocks.

By Myles Udland, reporter and anchor for Yahoo Finance Live. Follow him at @MylesUdland

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