Market chatter is suggesting this rally has room to run until inflation rears its ugly head
Last week we wrote about how the existing trends from 2020 remained in place as the new year began. As the week progressed, we learned that this was true from an investment psychology perspective as well. What do I mean by this? For most of 2020, there were plenty of reasons to be concerned about the market. Had you let these “reasons” and the emotions that they triggered enter into the investment process, you would have had a terrible year as an investor.
As 2021 got underway, the market continued higher with a solid first week across the board, here in the US and abroad. Another trend that continued was the market’s uncanny ability to ignore what was happening in the “real world.” Many clients wondered why stocks were not cratering last Wednesday. The charts barely blipped to the downside as the US Capitol was breached all the way to the Senate floor. The message of the market is clear. Liquidity and stimulus are the biggest drivers right now. As long as both of these elements are in play, the path of least resistance is to the upside.
The biggest variable we are watching is inflation? Why?
In general terms, the bond market will rally when increases in the CPI numbers are small and the bond market will fall when increases in the CPI are large.
The equity markets generally follow the same trend as the bond market when responding to CPI numbers. In other words, the equity market will (generally) rise when CPI numbers are small because low inflation leads to low-interest rates, which are good for corporate profits.
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CPI Numbers Trending up in December
Over the last 12 months, the all items index increased 1.4% before seasonal adjustment.
• The seasonally adjusted increase in the all items index was driven by an 8.4% increase in the gasoline index, which accounted for more than 60% of the overall increase.
• The food index rose in December, as both the food at home and the food away from home indexes increased 0.4%.
• The index for all items minus food and energy increased 0.1% in December.
Food inflation is the key variable to watch as a result of possible higher min wages
If CPI creaps up, this may end the stock market rally, but I don't see this to be an issue for at least a year.