Traders confront inflation’s reality

Bloomberg

For almost a decade, investors have waited patiently for any hint of inflation in the US economy, a sign the recovery can sustain itself without emergency stimulus from the Federal Reserve. Now they’re getting it, and many are shocked at the reaction.
It landed with the worst stock market plunge since January 2016. A stronger-than-expected employment report with signs of strengthening wage growth sent the Dow Jones Industrial Average down 666 points on February 2, bringing its five-day loss to almost 1,100 points. Share volatility surged.
Accounts of how concerned investors should be ran the gamut, from confidence traders will rush in and buy the dip, to warnings this time is different—that selloffs that begin in the bond market have a habit of snowballing.
“It is now signalling, potentially, the end of this eight-year bull rally,” said Rich Weiss, chief investment officer and senior portfolio manager of multi-asset strategies at American Century Investments. The firm manages $179 billion. “The Fed is going to have to move the interest rates, the bond market is recognising that this incremental economic growth will spur on inflation from various sources.”
Little escaped the selloff. All 11 industries in the S&P 500 tumbled, a coordinated plunge that hadn’t happened since the run-up to Donald Trump’s election. Yields on 10-year Treasuries surged as much as 6 basis points to 2.85 percent, the highest in four years. Oil dropped and the Bloomberg Commodity Index capped its biggest weekly slide in two months.
Of all the threats, surging Treasury rates and their implications for inflation are vexing investors the most, with this year’s half-percentage-point climb calling into question a valuation case on equities tied to how much more you get from corporate earnings than in bond interest.
“It’s kind of a strange time and we seem to be driven by a fear of what everyone wants, and that’s higher rates,” said Joe “JJ” Kinahan, the chief market strategist at TD Ameritrade. “Higher rates confirm a stronger economy, and the market was very afraid of that all week long. And that’s been a big reason for selling.”
Strategies that worked for years buckled in the rout. About 27 million shares changed hands, the most since the Brexit vote.
An irony for bulls is that the selloff arrived amid one of the best rounds of corporate earnings upgrades ever seen in the S&P 500.
Combined estimates for 2018 profits among companies in the index have gone from $145.90 a share on December 15 to $156.20 on February 2, a rate of increase that is four times faster than any stretch since at least 2012, data compiled by Bloomberg show. Using 2018 estimates, on the other hand, stocks fetch a slightly sturdier multiple of 17.7, while going out to the 2019 forecast of $172.30 takes the P/E down to 16.
“During the core of earnings season, stocks almost always react to whatever their earnings announcements are, and broadly, earnings were positive,” Kate Warne, investment strategist at Edward Jones, said. “But as investors worry about whether this is enough and whether it can continue, we’re likely to keep seeing stocks become more volatile.”
Central to the current anxiety is how far stocks have come in so short a time. January’s 5.6 percent gain in the S&P 500 was the biggest for any January since 1997, and using the index’s total return it has now risen for 15 straight months.