For markets, inflationary fears come with risks of recession
“Sell in May and walk away,” goes the old market adage, referring to the tendency for stocks to underperform from May through October. The third week of May 2022 could be seen as a bigger tipping point. The sharp falls in US and other markets last week were when a selloff that had started in the more speculative assets and tech stocks and spread to more profitable and established tech names became much broader. This reflects a change in investor sentiment. Concerns about inflation were joined by worries about recession – a recession that central banks could cause or deepen in their efforts to cool economies.
The catalyst, surprisingly, was revenue from two of the biggest big-box retailers, Walmart and Target. Both said sales increased but profits fell due to rising costs and tighter margins. Both saw double-digit price declines closer to the moves seen in non-profit growth stocks than in reliable sellers of consumer goods. The market sell-off spread to other consumer staples stocks.
Clear signs that even these powerful retailers were struggling to pass on cost pressures have prompted investors to fear that record corporate profit margins and buoyant consumer spending in the United States, which have supported market returns these last few years, come to an abrupt end. This took concerns into new territory. Previously, the withdrawal of cash after years of cheap money had mostly scoured the more speculative assets, including cryptocurrencies. The prospect of higher interest rates has primarily hit technology and growth stocks whose valuations hinge on higher earnings in the distant future.
Growing concern about the impact of the Federal Reserve’s response to inflation coincides with problems elsewhere. The lockdowns caused by China’s zero Covid policy are both stunting domestic growth and numbing international supply chains. European consumers are being squeezed by soaring energy prices due to Russia’s war in Ukraine.
That leaves markets at a delicate point, and some fund managers fear that if they enter a steeper slide, structural issues could amplify price drops. A new generation of portfolio managers has limited experience in managing bear markets. Trading conditions are tougher, in part because banks have been forced by capital adequacy rules to store intraday securities and smooth large moves as they did before the 2008 financial crisis. who have made bad speculative investments may be forced to sell off better quality assets.
Such doomsday scenarios might not happen. A closer look at Walmart and Target’s earnings reveals that they have accumulated unusually large inventories – in Target’s case, big-ticket items such as furniture and TVs that consumers were buying during the pandemic but less now – and have had to cut prices to clear them. If what we’re seeing is any sign that a late shift in the pandemic – the bias in US demand toward goods and away from services – is playing out, it could help rein in inflation by removing a force that had been supercharging the markets. price of goods. The asset price falls to date will also have wealth effects that could still make it easier for the Fed to meet its targets without raising rates as far as it might have expected.
With US inflation above 8% and Treasuries – unusually – also sold off in recent weeks, there are few safe places for investors. Commodities and energy stocks may be safer than some, though investors may need to be wary of ESG concerns. But amid such uncertainty, another market adage that has proven a successful strategy during recent corrections – “buy the dip” – doesn’t seem like a safe bet.