There has been quite a bit of “noise” lately about equity valuations, interest rates, and inflation. We thought it helpful to provide some perspective on these complex and transient topics using a Q&A format.
The stock market has been moving higher since 2009. How long do bull markets typically last?
This bull market is 12 years old – it started during the spring of 2009. Historically, secular bull markets tend to last 16 to 20 years (1949 – 1966 or 1982 – 2000). If the past is any indication of this bull market, we have another 3 to 8 years left.
What is the biggest threat to stocks in the medium term and also the long term?
As many of you know, the stock market will most likely continue to climb if corporate earnings remain strong and continue to increase. We think profits of the 500 largest companies (S&P 500) will hit $200 this year (+~15%) and will be up 10% next year (2022). If these assumptions are correct, stocks should continue to move higher. The biggest risk to our long-term stock market outlook is inflationary pressure.
Are stocks currently overvalued? The talking heads keep mentioning the high P/E ratios.
When using price/earnings to assess the value of the stock market, one must use historical data over the past year. Given that the world temporarily shut down in 2020, a look in the rearview mirror today still paints a bleak picture for stock market valuation. This same thing happened in May 2009 following the Great Recession caused by the 2008 financial crisis. Earnings were deflated while investors were already pricing in the impending recovery. The result? The highest price-to-earnings (P/E) ratio on record (123.73 in May 2009 while the long-term average is around 15). As we know now, May 2009 turned out to be one of the best times to buy stocks in our lifetime!
Why are we seeing inflation now? The most recent monthly Consumer Price Index (CPI) reading has me concerned.
This is not a simple question with a simple answer. There are multiple reasons we are seeing inflation right now… let’s discuss a few of the key contributors:
1) The U.S. economy is recovering rapidly. Trillions of dollars that have been pumped into our economy via the Federal Reserve over the past 12 months. There is more demand for goods because people have extra cash on hand due to government subsidies, tax credits, lower personal spending, etc. For example, retail sales are far above where they would be even if 2020 had never happened.
2) The Federal Reserve has said that they plan to keep short-term interest rates close to zero for another 12+ months. We think short-term interest rates could rise quicker than expected. As many of you know, the Federal Reserve will increase short-term interest rates in an attempt to prevent the economy from overheating. One can make a fairly compelling argument that we are on the road to an overheating economy if the federal government continues to infuse trillions of dollars into the economy with various new spending programs.
3) Some (but not all) of this inflation will be transitory. We are comparing the current consumer price index to spring 2020 when inflation was very close to zero. Last spring, the Federal Reserve was much more concerned about deflation, not inflation.
4) There is a current supply/demand imbalance. We have seen a 17.9% increase in retail sales when compared to February 2020. That being said, manufacturing was down 2.7% when compared to February 2020. This is in part due to the supply chain issues we are seeing (i.e. chip shortages for cars).
The bottom line is this… we think we will see higher inflation over the next 12 to 18 months when compared to the last few years. With that being said, we are not concerned at this point with “runaway inflation.”
What are your thoughts on bonds in a rising interest rate environment?
Late last year, we believed medium and long term interest rates would move higher. Going in to 2021, we thought it prudent to take a more interest-rate agnostic approach in both the taxable and non-taxable fixed income accounts that we manage for clients. Currently, we are still more willing to take credit risk over interest rate risk.
About the Author
Matt Price serves as a Partner and Senior Vice President for The Price Group of Steward Partners. He resides in Houston with his wife, Emily, their three children and the family golden retriever. Matt studied at the University of Pennsylvania – Wharton School of Business for his Certified Investment Management Analyst (CIMA®) designation after receiving his undergraduate degree from the University of Tennessee - Knoxville. Over the past 10 years, Matt has helped families make high quality, common sense decisions regarding their wealth and their legacy. Matt firmly believes that everyone needs a wealth coach!
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Any opinions are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. 3600037