Morning Brief: Strategists don’t believe inflation is a problem for the stock market

Wall Street strategists still remain largely unbothered by the recent acceleration in prices. Yahoo Finance’s Myles Udland weighs in.

Video transcript

- But first, we start this hour as we frequently do with the morning brief. And Myles Udland inspired me to take a look at some of the Fred data, the st. Louis Fred data on what has been happening with inflation over the longer term. The much longer term looking back to the 1970s when there was really hot, persistently hot inflation. And I looked at the 70s in particular because Myles wrote about how some strategists are reflecting on how this period compares to other periods of hot inflation.

And Myles, it seems like the conclusion is this ain't the 70s. And we're not going to see the same kind of stagflation and also effect on the markets that we saw back then.

MYLES UDLAND: Yeah, look. I mean, normal people care about inflation because people care about how much the cost of what they buy goes up over time. But the reason the markets care about inflation is because, basically, inflation tells you how aggressive the central bank will or will not need to be in raising interest rates in the future.

And all else equal, when the central bank has interest rates set lower and its policy is more accommodative, that's better for the stock market and other financial assets. Basically, anything that is riskier is going to, in general perform better during periods of easy monetary policy. And then you will have more challenges for those assets in periods of tighter monetary policy.

So the question around inflation today is basically, will the Fed need to act more quickly? Right now, most strategists think the answer is no. That is good for the market. Another thing that is good for the market in general is when the economic cycle is improving. And as we see here on this chart, earnings expectations both for this year or next year and for 2023 have continued to go up and to the right. A general confirmation that the economic cycle is going to continue expanding.

If we go back in time to the prior high for S&P 500 earnings, yes, we made a record high in 2019. It was a record high by about 1% over 2018. Obviously, the gains from 2020 to 2021 are going to be outsized. But we still have the street looking for low double digit percentage gains in 22 and 23 on corporate profitability. So again, the economic cycle is going up and to the right. In general, a good thing for the stock market.

And so if you go back to the 1970s, the problem then was you had stagflation. And what is stagflation? Stagflation is very simply when the economy is not growing. So you did not have those kinds of positive earnings revisions. And also, the central bank is tightening monetary policy in response to inflation. So you had the conditions for financial assets as set by the central bank deteriorating while you had the fundamental drivers of those assets of the underlying business behind those assets also deteriorating. Not a great setup.

Today, we actually have the opposite. We continue to have easy monetary policy and an expanding economic backdrop. And I think it is just worth reiterating as we look at, you know, highest stints type inflation data. 2008 on the headline, 1992 on the core, which as we all know, is before Brian Cheung was even born.

As we continue to see that data rolling in, it is just worth remembering the very broad outline of this setup. Which is that the central bank remains easy. Is not likely to be moved off of that position. And the economy is growing. And it's just very, very difficult to build a longer term structural bear case for financial assets, most notably stocks and lower quality of fixed income type assets against that backdrop.

And while you can have periods like we've had for, you know, the big cap tech leaders, where you have flat market for six months. I mean, even look at 2014 to '16, the market kind of went nowhere for a couple of years. And it was a very painful period.

But right now, with the economy growing and monetary policy remaining easy, it is just very challenging to look at these types of shorter term data, these one off data events and get excited about a tough period for the market. And I just think that's worth reiterating as we come into, again, a big week for not only that data but Fed commentary with that announcement and the presser on Wednesday.

- And Myles, important to point out too for new viewers. Our senior Fed correspondent Brian Cheung was born in 1993. But I did want to know, curious what you think about this, Myles. You're looking at low rates really for the next five years. I mean, we have so much focus on dot plots this week. Perhaps the Fed raises rates at some point in 2023. Even still, that's still a pretty fertile backdrop for stocks. I mean, it's not like rates are going up to 6% 7% anytime soon.

MYLES UDLAND: I mean, I don't think that whenever this rate hike cycle gets underway, any of us think it'll look much different from the 15 to 18 cycle, right. You had one hike a year for '15 and '16. Then you had, I guess, what was it? It was a hike each quarter from Q4 '17 through the fourth quarter of 2018. And then you had-- or the third quarter of 2018. And then you had the reversal.

And the Fed started announcing that it would likely cut its interest rate at the beginning of 2019. Then it eventually did cut interest rates in 2019. And so I think that, you know, we'll find out what the market can handle, or be comfortable with when we get to, you know, 1 and a 1/4, 1 and a 1/2 percent on the Fed funds rate.

But yes, honestly, I don't think anybody believes that we'll be looking at 5% Fed funds rate given this backdrop. Because we're very quickly here going to move from, Oh the economy is expanding into all those demographic headwinds we all, you know, came to learn so well during the second half of the last.