US inflation brings no respite for markets

As US inflation hit a 40-year high, the benchmark S&P 500 stockmarket index slid into a bear market, down more than 20% since its 3 January high.

US Federal Reserve building
Traders expect the US Federal Reserve to raise rates faster
(Image credit: © Brooks Kraft/ Getty Images)

“The bigger the party, the worse the hangover,” says Russ Mould of AJ Bell. America’s S&P 500 plunged on Monday to close down more than 20% since its 3 January high, meaning that the benchmark index is officially in a bear market. That marks the end to the bull market that began in March 2020. While it was “the shortest bull run on record since 1950… what it lacked in duration it made up in intensity”.

The sell-off followed data last week showing that US consumer price inflation hit an annual rate of 8.6% in May, the highest level since 1981, dashing hopes that it had peaked. The unexpectedly high figure increases the odds of sharp interest rate rises. Traders are now betting that the US rates will be at 3.6% by the end of 2022, up from expectations of 2.9% last week.

Tech stocks have been hit especially hard, with the tech-heavy Nasdaq down 28% since the start of the year. Yet the bear market is broadening to include sectors that had been safe havens so far this year, says The Wall Street Journal. The S&P 500’s energy segment plunged 5.6% on Monday, “a deeper decline than that of the broad index”. On the same day, ten-year US treasury bonds registered their worst one-day performance since March 2020, as yields hit their highest level since 2011.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Structural inflation

The US inflation data was “awful” and got “worse the more you looked”, says John Authers on Bloomberg. Energy prices soared 34.6%, their biggest annual increase since 2005, while food costs were up 10.1%. Policymakers might be able to do little to control soaring commodity prices, but rising rents and house prices have also sent US shelter inflation to its highest level in three decades. “Plainly, tighter monetary policy should help rein in an overheating housing market”.

For central bankers, “easing the inflationary economy onto the runway safely and comfortably is all that matters” now, says Tom Stevenson in The Daily Telegraph. Such a “soft landing” would require “just enough demand destruction and a resumption of sufficient supplies of key inputs like energy” to tame inflation. In a “hard landing”, by contrast, “central banks go too hard, too fast and push the economy into recession, either by accident or deliberately”. A “third possibility is a continuation of the current stagflation environment in which central banks remain behind the curve”, a scenario that would amount to “a re-run of the ugly 1970s economic backdrop”.

There are good reasons to fear that high inflation is here to stay, say Marco Pirondini and Alec Murray of Amundi Asset Management. There are structural labour shortages in the US and China, not to mention the inflationary impulse from higher global spending on defence and energy security. In such an environment investors will begin to “reward companies based on their current fundamentals rather than on earnings potential in the distant future”. In the first four and a half months of this year, the least expensive quintile of S&P 500 stocks returned 6%, while the most expensive fell 23% as investors “shift from paying any price to paying the right price”.


What to buy as the tech-stock bull market crashes

Protecting your wealth from inflation won’t be easy – here’s what to do

We’re in a bear market – change the way you invest