What this does above all is generate more uncertainty, which can be a paralyzing force for markets and investors.
Rising inflation can be good for the economy and consumers up to a point, but a 7.5% jump in the consumer price index in January was well ahead of the Federal Reserve’s average target of just 2%. One implication of consistent rising prices is that the Fed will need to tighten monetary policy in an attempt to tame the economy and keep inflation in check.
Initially, the Fed viewed rising prices as transitory, pinning the blame on temporary supply chain disruptions that would likely work itself out and lead to a normalization in prices. But as supply chain issues persisted, especially in the semiconductor industry, consumer demand for goods remained incredibly high.
The resilience of the US consumer, combined with longer-than expected supply chain disruptions, led the Fed to ditch its “transitory” view on rising prices and shift to a stance that it needs to raise interest rates a lot quicker than originally expected.
And that’s bad news for risk assets, like stocks, which have been conditioned to expect accommodative monetary policy from the Fed since the aftermath of the 2008 Great Financial Crisis.
In fact, ever since the Fed pivoted to a more hawkish stance in December, the stock market has trended lower following an almost two-year period of strong gains. The S&P 500 was down more than 10% from its record high before Russia’s attack, as investors grew increasingly skittish of an expected interest rate hike at the Fed’s meeting next month.
Only compounding the disappointment of investors in recent weeks has been less-than-stellar earnings results, which while mostly positive have not been enough to beat analyst expectations. Combined with strong comparables from last year and heightened investor expectations, slight earnings misses from fast-growing companies like Meta Platforms, Roku, and PayPal led to more than 20% single-day declines in their stock prices.
When you add it all up, you get a heightened period of uncertainty for the stock market and investors. And risk still lies ahead, as ccommodity prices continue their surge following Russia’s attack on Ukraine, only exacerbating inflationary pressures and the likelihood that the Fed has to get serious about raising interest rates in an attempt to reign in rising prices.
But in the long-term, the stock market has a way of overcoming uncertainty and climbing the proverbial “wall of worry,” as long as companies can continue to grow their earnings.
“While these building headwinds are creating short-term uncertainty, these should largely dissipate/fade before the first half of 2022. And thus, the set-up remains that we see equities as treacherous in 1H but stronger in 2H,” Fundstrat’s Tom Lee said in a Wednesday note.