Should Investors Be Preparing for Inflation?

U.S. equities gave up ground on each of the four trading days last week. The cumulative loss was minimal, just 0.7 percent, but stocks were unable to rally on what was mostly stronger than expected economic data. Retail sales surged higher by 5.3 percent in January, crushing consensus forecasts of a 1.1 percent gain. Industrial production was more than double consensus. The flash PMI report for February showed unexpected strength in services, offsetting a slight decline in manufacturing from the prior month. Existing home sales, building permits, and the homebuilders index all moved higher as well. Only housing starts and weekly jobless claims disappointed. The dollar edged fractionally lower last week, but the VIX saw a notable increase. After ending the prior week below 20 for the first time since the selloff began last February, the VIX closed at 22, and is moving higher to 24 in early trading this week. 

Investors Can’t Ignore the Market’s Excess

It is getting increasingly difficult to ignore the signs of market excess. The list has long included absolute measures of stock valuation that are near their historical highs, including Price/Earnings, Price/Sales, Price/Book Value, and Price/GDI. Of course, the counter argument has consistently pointed to the historically aggressive fiscal and monetary support, and the promise of more to come on both fronts. This counter argument has also consistently pointed to the relative valuations of competing asset categories, like bonds and cash, as being so unattractive they offer no competition at all. Last week, this prevailing sentiment led to a record dollar amount of flows into global stock funds at $58 billion. And all of this has contributed to the surge in such speculative plays as cryptocurrencies and the current favorites of the momentum crowd on social media.

The Market Moving Power of Social Media and Commission Free Trading

After reaching a new record closing high on Monday at 3855, the S&P 500® index turned lower to record its worst week since the end of October. The index subsequently fell 3.7 percent, seemingly unnerved by the spectacle of the extraordinary short squeeze in GameStop stock, and a handful of other names. So far, the selloff is modest, but it does leave the S&P 500 lower for the year, down 1.1 percent. And high absolute valuations did leave stocks somewhat vulnerable. The S&P 500 closed fractionally below its 50-day moving average at week’s end. The degree of support at that level will no doubt be tested this week. While just about every sector was lower, cyclical stocks were the weakest. Small stocks fared even worse than large, as the Russell 2000 index fell 4.4 percent, but is still higher on the year by 5 percent.

Investors React to a Series of Changes from the New Administration

U.S. equities resumed their winning ways last week after a one-week hiatus, as the S&P 500® index gained 1.9 percent. Most of that gain came on Inauguration Day, after which the rally petered out as the new administration began to settle in. The index is now higher on the year by 2.3 percent. Both the dollar and the ten-year note yield were little changed on the week.