Please note: This update was prepared on Friday, June 11, 2021, before the market’s close.
The markets have adopted an Alfred E. Neuman stance on inflation: What, me worry?
In a report eagerly awaited by traders and investors alike, the Labor Department announced Thursday that consumer prices were 5% higher in May than a year ago, signaling the biggest inflation surge in nearly 13 years—and Wall Street barely missed a beat.
The S&P 500 hit an all-time high, while both the Dow Jones Industrial Average and the tech-heavy NASDAQ Composite are within a percentage point of their respective records. Meanwhile, bond prices rose and yields backed off a bit.
That’s hardly what you’d expect if hotter-than-anticipated inflation was seen as a harbinger of things to come. The laidback response signals an overwhelming belief by investors that today’s inflation picture is likely transitory, resulting from pandemic-related price irregularities and short-term labor and supply shortages.
Ongoing vaccination success, an improving job market and record-level U.S. household wealth have kept stocks on the rise so far in 2021. On a total return basis, the Dow Jones Industrial Average and the broader S&P 500 have each gained 13.6% for the year. The MSCI EAFE index, a measure of developed international stock markets, has returned 11.6%. The Bloomberg Barclays U.S. Aggregate Bond index’s yield stood at 1.44%, up from 1.12% at the end of 2020, but down from 1.61% at March’s end. Overall, the U.S. bond market has declined 1.6% year-to-date.
Looking Past Overheated Headlines
INFLATION IS RUNNING AT 5%!
Yes, Thursday’s data made for splashy headlines. Consumer prices rose at the fastest rate since 2008. It’d be worrisome if this wasn’t the result of the same kind of distorted data we’ve seen for some time now on everything from jobs to wages to supply and demand misalignment.
First, that 5% CPI rate for May is dramatically impacted by the base effect (see “Inflation Duration Explained”), comparing today’s numbers with a year ago—during broad pandemic shutdowns—when inflation was supposedly running at 0.1% year-over-year (and the annualized rate of inflation for the three-month period suggested deflation of 4.4%).
Fast-forward to today and prices are up most dramatically in the sectors and industries disproportionately affected by lockdowns, including hotels, airfares, rental cars and used vehicles, as Americans shake off cabin fever and hit the road for vacations and visits with friends and family.
If we were really facing rapid and sustained inflation, we wouldn’t see the 10-year Treasury bond—the benchmark against which virtually all other interest rates are compared—trading with a yield below 1.50%, down from 1.74% at the end of March.
Stated simply, if lasting inflation was a legitimate concern, yields would be higher, not lower. And, as you can see in the chart above, the bond market’s inflation outlook (gauged by the differences in yields between 5-year and 10-year Treasury bonds and Treasury Inflation-Protected Securities of the same maturities) has been falling since about mid-May.
Economists agree. The Philadelphia Federal Reserve’s latest survey of forecasters shows average inflation expectations of 2.3% over the next decade, close to what the market is pricing in.
The current wave of inflation is real but it’s not a long-term trend. That’s our story and we’re sticking to it.
Can Hiring Tame Price Pressures?
For anyone wondering if our jobs problem is because people are satisfied with enhanced unemployment assistance (which, in turn, has helped push the reservation wage higher—see “Labor’s Labored Recovery”), we’re about to see. Some states are ending federal unemployment benefits on Saturday with others following suit within weeks. The assumption is that more people may head back to work.
If that happens, they’ll enter into a hot labor market. New unemployment claims fell for the sixth straight week, job openings are at a record level, layoffs are as low as they’ve been since at least 2000 and Americans are quitting jobs at a record pace (a high “quit rate” is seen as an indicator that workers are confident they can find a better job elsewhere). What’s more, small-business owners are optimistic and ready to hire, but they’re having trouble finding qualified candidates.
How does all of this impact inflation? If the workforce expands, the newly employed have less time for online shopping and more time to make goods and provide services. If that happens, we’ll see demand (and prices) moderate and wage pressure ease up as hiring becomes less competitive.
Under this scenario, the bond market backs up our assertion above: High inflation is temporary.
ESG Investing: Our Perspective
This week’s reader question concerns “socially responsible” investing: What is your perspective on ESG investing and how should we, as investors, be thinking about this opportunity (particularly considering Biden’s legislative agenda)? Are companies with strong “ESG scores” higher-quality companies that we should be focusing on?
Research Analyst Liz Laprade had this to say:
ESG investing has grown in popularity in recent years, but at Adviser Investments, it’s business as usual.
In the simplest of terms, the goal of ESG investing (the acronym stands for “environmental, social and corporate governance”) is to invest in companies that are cognizant of how their businesses affect the environment and are taking steps to protect it, treat their customers and employees right, and are run by people focused on boosting shareholder value in an ethical and responsible way.
Put like that, you realize that those are factors that good stockpickers should always consider—regardless of whether their funds or portfolio objectives are labeled by platforms and product providers as “ESG” or not.
The tricky part of investing in self-described ESG funds is that the there is no agreed-upon metric for scoring companies on ESG measures.
Even companies with strong “ESG scores” based on one or another measure aren’t always synonymous with high quality. Often, companies score well in only one or two out of the three ESG pillars, yet their scores average out to a good overall ranking.
Take Tesla, for example. Some ESG raters score it highly on environmental factors. Others would contend, though, that Tesla’s automotive batteries are the product of rapacious mining for raw minerals and hence should rate lower on environmental scores. The company also arguably rates lower in corporate governance given founder Elon Musk’s sometimes outrageous behavior and flouting of regulations.
For us, ESG factors are an important part of whether a stock is a buy or sell. Score or no score, we think it’s a positive that corporations are being pressed by investors to make their companies cleaner and more socially responsible. It has always been (and will always be) important to consider ESG and any unethical or environmentally irresponsible event when making investment decisions on a given stock. We certainly do.
In terms of the Biden administration’s agenda, a climate-change push would benefit electric vehicle and renewable energy companies. It would also have a further benefit for manufacturers supplying parts to these companies. If environmental legislation were to pass in Washington, we will do our best to position our bottom-up portfolios to capture the upside as companies prepare for climate change and fight against it.
Financial Planning Focus:
New and Improved FAFSA Rules
Is college on the horizon for your kids or grandkids? Then you need to know about some important updates to the Free Application for Federal Student Aid (FAFSA). If this is a new acronym for you, FAFSA is the main form you’ll use to apply for student financial aid.
The recent revisions were passed by Congress in 2020, though they won’t kick in until the 2023–2024 academic year. Here’s a rundown:
The form is shorter. While the old FAFSA weighed in at an imposing eight pages with more than 100 questions, the new form has been cut to just two pages with fewer than 40 questions. We’re hoping that this new streamlined version removes some of the complexity and proves simpler to complete.
The “Expected Family Contribution” is rebranded. If you’ve filled out the FAFSA in the past, then you’ve likely come across the phrase “Expected Family Contribution” (EFC), a bit of jargon for how much of a student’s college costs a family is expected to pony up—and therefore, how much aid the student is eligible for. In other words, it’s a critical number. The new FAFSA replaces the EFC with a “Student Aid Index,” which is expected to be calculated slightly differently. The Student Aid Index may mean more assistance for students from lower-income families and less for those from middle- and upper-income households, particularly those with multiple scholars in school at the same time.
No automatic assistance for multiple students. At present, having multiple students in college simultaneously usually makes you eligible for additional financial aid. This break is eliminated under the new Student Aid Index. Your aid eligibility is based on overall need regardless of the number of students you claim as dependents.
Grandparent 529s don’t reduce aid eligibility. This is a major change. Under current FAFSA reporting rules, a 529 plan (college savings account) owned by a dependent student or a dependent student’s parent has relatively minimal impact on eligibility for need-based financial aid. Whereas, a 529 owned by anybody else would be treated as the child’s untaxed income. When the new FAFSA goes into effect, starting in 2023, that will no longer be the case. Grandparents, aunts and uncles, or others outside the immediate family will be able to help with college costs without significantly reducing a student’s aid eligibility.
It is likely that further guidance will be released over the next few years as the transition to the new FAFSA gets closer. We’ll be sure to keep you updated as information becomes available.
Strategy Activity Update
Please see below for a summary of the trades we executed over the week through Thursday and our current tactical strategy allocations.
Sold Organon (OGN). Reduced Bank of America (BAC) and Blackrock (BLK). Increased Lockheed Martin (LMT). Bought Procter & Gamble (PG).
AIQ Tactical Global Growth
Sold iShares Core S&P 500 ETF (IVV). Bought Invesco Dynamic Leisure and Entertainment ETF (PEJ).
AIQ Tactical Defensive Growth
No trades this week.
AIQ Tactical Multi-Asset Income
Sold iShares National Muni Bond ETF (MUB). Bought Fidelity Corporate Bond ETF (FCOR).
Next week, we’ll get useful reads on retail sales, inflation, manufacturing, homebuilding and leading economic indicators. The Federal Reserve also convenes for a scheduled two-day meeting, culminating in a Wednesday afternoon press conference from Chair Jerome Powell to discuss where policymakers stand on their latest thinking.
As always, you can visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.
Please note: This update was prepared on Friday, June 11, 2021, before the market’s close.
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