Specter Of Inflation And Rising Interest Rates Shock S&P 500
Summary
- Although stock prices saw considerable volatility during the week, investors appeared to largely maintain their forward-looking focus on 2021-Q2.
- But a shock event like the bond market's "tantrum without a taper" could compel investors to shift their focus to a different point of time in the future.
- At present, assuming no change in the expectations for future dividends, the worst case would be if investors shifted their focus to the current quarter of 2021-Q1, where they would be watching for the Federal Reserve's response to the bond market's "tantrum" within this quarter.
- If that happened, stock prices could fall on the order of somewhere between 200-300 points.
There was exactly one big story driving the action for the S&P 500 (Index: SPX) in the final week of February 2021. Incoming data suggested the specter of inflation is not as distant as had been assumed. With its appearance, investors who had hedged their bond investments by buying stocks were shocked into selling to cover their losses as real interest rates for the 10-year U.S. Treasury rose above 1.5%.
For the S&P 500, although stock prices saw considerable volatility during the week, investors appeared to largely maintain their forward-looking focus on 2021-Q2, with the index's level remaining within the redzone forecast range we described in our previous update.
The new volatility does raise an interesting question for our redzone forecast. What would it mean if the level of the S&P 500 moved outside of the indicated range?
From our perspective, all that means is that circumstances have overridden the assumptions we made when we established it. As shown, it is based on the premise that investors would be focused on 2021-Q2 in setting current-day stock prices in the early period covered by the redzone forecast, where they would transition to focusing on the more distant future quarter of 2021-Q4 sometime after March 2021.
But a shock event like the bond market's "tantrum without a taper" could compel investors to shift their focus to a different point of time in the future. At present, assuming no change in the expectations for future dividends, the worst case would be if investors shifted their focus to the current quarter of 2021-Q1, where they would be watching for the Federal Reserve's response to the bond market's "tantrum" within this quarter. If that happened, stock prices could fall on the order of somewhere between 200-300 points. In the alternative futures chart, we would see the level of the S&P 500 drop below the redzone forecast range.
If investor expectations for future dividends change on top of that, then the level to which the S&P 500 might go in that scenario would be affected to the extent those expectations change. We would see that change through the changing levels of the dividend futures-based model's alternative projections of where the S&P 500's level would be for when investors focus on particular points of time in the future.
The behavior of stock prices is complex, but not difficult to sort out if you have the right framework for understanding why they behave as they do. Regardless, the one thing that will determine how they behave in the immediate future in the random onset of new information. Speaking of which, here is our summary of the previous week's news flow of market-moving headlines, which provides a good portion of the context needed to understand what new information investors were absorbing during the most volatile week for markets in months.
Monday, February 22, 2021
- Signs and portents for the U.S. economy:
- Fed minion expects strong recovery:
- Bigger stimulus developing in the Eurozone:
- ECB minion swears there is no risk of lasting inflation in the Eurozone:
- Nasdaq, S&P 500 end lower as U.S. yields rise; Disney lifts Dow
Tuesday, February 23, 2021
- Signs and portents for the U.S. economy:
- U.S. manufacturers grapple with steel shortages, soaring prices
- U.S. consumer confidence improves as COVID-19 cases fall; house prices accelerate
- Oil settles mixed amid post-storm uncertainty
- U.S. bill rates risk going negative, but stimulus could change the course
- Analysis: Bubbles, bubbles bound for trouble?
- Analysis: Prices lurch higher as Home Depot, other importers battle surging cargo, commodity costs
- Fed minion speaks to Congress, sees rapid growth once virus-fear driven lockdowns are lifted, not afraid of inflation:
- Fed Chair Powell's prepared remarks to Congress, Feb. 23, 2021
- Fed's Powell: 2021 GDP growth could be in range of 6%
- Powell says economy still needs Fed support, pushes back on inflation worries
- Powell's Econ 101: Jobs not inflation. And forget about the money supply
- Is Fed Chair Powell 'cool' with more fiscal aid? Suddenly he won't say
- Inflation also developing in the Eurozone:
- S&P 500, Dow close higher in late session turnaround
Wednesday, February 24, 2021
- Signs and portents for the U.S. economy:
- Fed minions face negative rates, need Congress approval to launch digital currency, see need for endless monetary stimulus, but think future looks bright:
- Mixed signs of growth, recession in Eurozone:
- BOJ minions becoming concerned over endless monetary stimulus:
- Wall Street advances as Fed's Powell soothes inflation worries
Thursday, February 25, 2021
- Signs and portents for the U.S. economy:
- Fed minions super optimistic rapidly rising interest rates is a good thing, want to keep easy money policies:
- Atlanta Fed's Bostic says not worried about rise in bond yields with rates still comparatively low
- Fed's George says rise in long-term rates a sign of optimism
- Bullard: Jump in bond yields proper response to stronger growth, inflation outlook
- Quarles cautions pandemic stimulus could obscure risks for banks
- NY Fed's Williams: GDP growth this year could be strongest in decades
- Bigger trouble developing in the Eurozone:
- Positive signs of post-coronavirus recession recovery:
- ECB minion commits to keep Eurozone interest rates low indefinitely:
- Wall Street ends sharply lower, tech selloff weighs as bond yields climb
Friday, February 26, 2021
- Signs and portents for the U.S. economy:
- Bigger trouble with inflation developing all over:
- Positive post-coronavirus recovery signs in India, China, mixed signs in Japan:
- ECB minions standing by, seem okay with rising interest rates, but thinking about unleashing more QE:
- Nasdaq finishes higher, tech stocks retrace some losses
Meanwhile, Barry Ritholtz lists the positives and negatives he found in the past week's economics and markets news.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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