Inflation 2023
Inflation has been pulled down
It’s all in this next chart. It shows the 3-, 6-, and 12-month inflation rates last June versus last December.
As you can see, inflation is down across all three time frames… And it’s down a lot over the past 3- and 6-month periods.
Much of the plunge in stocks last year was a reaction to rate hikes from the Fed.
Since last March, when it began hiking rates, the Fed has brought its target rate from 0.5% to 4.5%.
That’s the fastest pace of rate hikes in U.S. history.
And higher rates lead to lower stock market valuations. This drags down stock prices.
If inflation has peaked, the Fed no longer has to crush the economy… and the stock market… with higher rates.
But don’t just take my word for it.
The next chart shows that stock market valuations and inflation mirror each other.
You’re looking at the price-to-earnings (P/E) ratio for the S&P 500 (blue line) and the annual inflation rate (orange line).
As inflation has risen, the P/E ratio has tended to fall. And as inflation has come down – like it’s doing now – the P/E ratio tended to rise.
That leads us to our second reason for optimism…
Junk bonds are corporate bonds that carry a high risk of default.
As a result, junk bonds carry higher yields than safer Treasury bonds.
That makes them useful weathervanes for how investors are feeling about risk.
If they’re worried about a recession, they flee junk bonds and seek out the relative safety of Treasurys. If they’re more optimistic about the future, they rush back into junk bonds to capture those higher yields.
Over the past 12 months, the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is down 11%. That compares with an 8% fall for the iShares 3-7 Year Treasury Bond ETF (IEI).
But when you look over the past three months, that trend has reversed.
HYG is up 6.8% over that time versus a 3.5% gain for IEI.
That’s not something you typically see heading into a recession.
If you had money in the stock market in 2022, your portfolio almost certainly took a hit.
The S&P 500 finished the year down 20%. The tech-heavy Nasdaq dropped 34%. And the Russell 2000 index of small-cap stocks plunged 23%.
But this year, all three indexes are up.
Year to date, the S&P 500 is up 4%. The Nasdaq is up 6%. And the Russell 2000 is up 7%.
We’re only 17 days into the new year. How can I say this rally is meaningful?
Because that’s the message from history.
The S&P 500 showed a positive gain for the first five trading days of this year.
The last 45 times the first five days have been positive, the full-year return was also positive 82% of the time.
And the average gain in those years was 14.3%.
This looks very good but will the FED be stubborn and still raise rates to get inflation down to 2% and will ultimately overshoot.
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