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Stock Market Slide Shows Inflation Worrywarts Were Right

Stock Market Slide Shows Inflation Worrywarts Were Right

Inflation has been at best an ambiguous influence on stocks this year, bearish in its impact on policy while bullish as an economic signal and because it’s lifted sales without shrinking margins. Wednesday was a rare victory for the worrywarts.

Stocks sold off after the biggest jump in consumer prices since 1990. The Nasdaq 100 dropped more than 1% for its worst decline in a month while richly valued shares bore the brunt of the selling. A Goldman Sachs Group Inc. basket of unprofitable technology firms tumbled roughly 4%, the most in a month. 

Granted, the retreat followed weeks of relentless gains during which the S&P 500 rose in 17 of 19 sessions through Monday, the best run since 1971. After the rally made almost everyone a bull, it doesn’t take much for the market to reverse course. And while corporate America has ridden inflation to record profits, the specter of sticking inflation and higher interest rates is something that doesn’t sit well with investors. 

Stock Market Slide Shows Inflation Worrywarts Were Right

According to Quant Insight, a London-based analytics research firm that studies the relationship between asset prices and two dozen macro factors, the S&P 500 showed negative sensitivity to rising inflation expectations last month for the first time in three years. 

“My sense is investors are more heavily discounting high growth stocks today as inflation remains red hot,” said Mike Bailey, director of research at FBB Capital Partners. “There could also be a bit of buyer’s remorse for growth and tech stocks after seeing a big lift in sentiment over the past month,” he added. “Now tech and growth buyers are worried that a nasty combination of higher inflation and rates along with expensive valuations will lead to bad news ahead.”

Investors sought safety in haven stocks like utilities and consumer staples as the CPI data rattled the bond market, with a measure of expectations for inflation surging to a record high. As traders accelerated estimates for when the Federal Reserve will hike its benchmark interest rate to tamp down inflation, the U.S. dollar jumped.  

What sets Quant Insight apart is an approach to mute out all other macro drivers while analyzing one factor’s impact. Using a tool know as principal component analysis, the firm studies inflation expectations -- as measured by inflation swaps on Treasury bonds -- and their influence on the stock market in isolation. And the message is clear: Inflation is no longer an ally for equity bulls. Both indexes tracking European and U.S. stocks have seen their sensitivity to inflation turning negative. 

Stock Market Slide Shows Inflation Worrywarts Were Right

The data is a rebuttal to those who say the stock market is immune to a force that has crimped the confidence of the average American. Yes, the S&P 500 held near record highs even as consumer sentiment plunged to pandemic lows. But a closer look shows the market is more tuned to inflation worries than one might have thought. 

“They don’t like rising inflation expectations anymore,” said Colin Stewart, head of Americas for Quant Insight. “Psychology of Main Street and Wall Street in sync.” 

Like many things in the post-pandemic era, it’s not clear whether the stock market will continue to treat inflation as a threat. Even after a two-day slide, the S&P 500 hovered around its all-time high and Quant Insight data showed other things such as corporate credit and market liquidity have still acted as a bigger driver for the S&P 500. 

But here is one note of caution: Should inflation angst worsen and stocks sell off, the market’s reliable savior -- the Fed -- may not be able to come to the rescue.  

“Rate hikes might not be enough to reverse inflation because the sources of inflation involve supply chain bottlenecks and fiscal spending, which are two areas that the Federal Reserve doesn’t control,” said Nancy Davis, founder of Quadratic Capital Management. 

©2021 Bloomberg L.P.