S&P 500 closes at record high as investors shrug off inflation fears

It’s 1450 out of 1500 ETF funds that I just wouldn’t touch because they’re not diversified enough. Or they have some huge speculative twist to them that if you can guess the markets right you will do very well for a day or two but who can do that? Nobody. – John Bogle

The S&P 500 Index closed higher for the third consecutive week and in the process, it established yet another record high as investors shrugged off inflation fears. The Nasdaq Composite Index, which has underperformed the other major averages this year, turned in the best performance of the week as bond yields fell despite higher than forecast inflation data. The Dow Jones Industrial Average bucked the trend by ending the week lower but it is still only slightly below its all-time high. For the second month in a row, inflation as measured by the consumer price index (CPI) topped expectations in May by rising 5% year-over- year, the fastest pace since August 2008. Surging used car and truck prices were responsible for much of the increase and the higher reading was due mostly to categories that have been affected by the pandemic and are under pressure from disruptions in supply. Prices for hotels, rental cars, sporting events and restaurants were also higher while medical care and shelter costs showed only modest increases. But the surge in inflation may be temporary as the Federal Reserve has maintained because the yield on the 10-year Treasury actually fell below 1.43% before ending the week at 1.46%. Earlier in the year, the yield on the 10-year Treasury had been as high as 1.77% and one would think that rising inflation would cause bond yields to increase, not decrease. The drop in bond yields was a major reason why the technology-laden Nasdaq Composite Index performed so well last week. Technology companies tend to lag in a rising interest-rate environment as higher rates lower the present value of future cash flows for growth-oriented companies. The surprising decline in the 10-year Treasury yield and other bond yields in the face of increasing inflation data could portend a slowing economy later in the year, which again would favor stocks that are more growth-oriented than value-oriented. Economic data bears watching over the next several months to see if any discernible trends develop to help clarify this issue.

Last Week

While the CPI for May was the primary focus for investors last week, weekly jobless claims totaled 376,000 and were slightly higher than estimates but still at the lowest level of the pandemic. The University of Michigan consumer sentiment index for June rebounded from May and was better than expected as inflation fears subsided and optimism increased over economic growth prospects. The Labor Department’s Job Openings & Labor Turnover Survey (JOLTS) showed that job openings in April climbed to a record 9.3 million, more than expected and indicative of a jobs market that is poised for stronger growth.

For the week, the Dow Jones Industrial Average dropped 0.8% to close at 34,479 while the S&P 500 Index gained 0.4% to close at 4,247. The Nasdaq Composite Index jumped 1.9% to close at 14,069.

This Week

Retail sales for May are expected to decline slightly after a flat April and the producer price index (PPI) for May is forecast to increase but by less than in April. May leading economic indicators are expected to increase above 1%, slightly less than in April while housing starts in May are forecast to exceed those in April, which were considered strong.

The Federal Open Market Committee (FOMC) meets this week and will announce its monetary policy decision, which most believe will leave the federal funds rate unchanged near zero. The Fed may also offer clues as to when it might reduce its monthly bond purchases, which currently stand at $120 billion. The Bank of Japan (BOJ) also meets and will likely leave its key interest rate the same at negative 0.1%.

The only companies scheduled to report their quarterly earnings this week are Oracle, H&R Block, Lennar, Adobe and Kroger.

Portfolio Strategy

The big event for the markets this week is the Federal Reserve meeting and investors will learn the outcome of the meeting on Wednesday afternoon. Until that time, the stock market is expected to trade sideways as investors await the Fed’s decision on its monthly bond buying program and interest rates. At the present time, the Fed is buying $120 billion of securities, a program that was begun during the onset of the pandemic and designed to provide liquidity to the markets and keep interest rates low. The Fed has indicated in past meetings that it will forewarn investors that it plans to taper its bond purchases long before it actually begins this process. This possible action would be the first step in a change in monetary policy and a switch from easing to tightening. As far as interest rates are concerned, the Fed has maintained in its forecast that there will be no increase until 2023 at the earliest. This forecast seemed plausible until recently as inflation was subdued and the labor market was slowly recovering from the effects of the pandemic. All of that changed, however, with the release of the consumer price index (CPI) for the last two months as the readings were well above expectations. Right now the markets are buying the Fed’s explanation for the rise in inflation as a temporary and transitory reaction to the economy reopening with disruptions in the supply chain and huge pent-up demand. The decline in the 10-year Treasury yield to just 1.46% shows that the bond market agrees with the Fed and that the economy is likely to slow later in the year. A disappointing jobs report in May that showed far fewer jobs created than expected also supported the notion of an uneven economic recovery. While it will be important to hear the Fed’s take on the economy and inflation, it also will take a few more months of data to determine whether or not higher inflation is here to stay.