Sector rotation across the major US equity indexes took hold this week. A broadly upbeat fourth-quarter earnings season had powered Wall Street's main indexes to record highs earlier in the month, but fears over an imminent inflation surprise dampened this enthusiasm as the month drew to a close.
Higher than expected inflation and Retail sales figures in January coupled with the pending $1.9 Trillion support package in the U.S is positive news in terms of an economic recovery but gave rise to fears over a faster than expected reflation timeline.
This prospect of rising inflation triggered caution over lofty equity valuations, hitting shares of high-flying technology-related companies. The COVID favourites, including Microsoft, Facebook, Alphabet's Google, Netflix and Amazon, fell as investors looked to bank some of the gains made since last March. Investors opted instead for cyclical stocks set to benefit from pent-up demand as the economy re-opens.
While the recent sell-off in some of the big winners of 2020 may be unsettling for those invested in these companies, it is a normal market function. The growth story of any stock will never be entirely linear, it will be littered with dips. For Tech stocks that have seen mammoth growth in recent times, the endless upward trajectory was unsustainable at current rates and inflation fears early in the week just applied the brakes to allow for a cooling-off period. As always, if you are passionate about the stock and the companies long-term future, these market corrections should be seen as buying opportunities.
Don't just take my word for it, here is actual footage of Cathie Wood and her ARK cohorts scrambling to buy Tesla during the dip this week
Bitcoin climbed to $58,000 per coin late last week. The cryptocurrency was up 100% in 2021 alone and finally surpassed 1 trillion dollars in market value. In true Bitcoin fashion, skyrocketing returns were interrupted by periods of violent crashes later in the week, with bitcoin falling as low as 44,000 early in the week, only to return to the 50K mark by the middle of the week as square announced a new $170 million investment in the crypto.
So, should you sell it all and hide your money under your mattress?
The idea that higher than expected inflation could negatively impact stock market performance was the major talking point this week. I understand where the argument is coming from. Firstly, any rise in bond yields will negatively impact the equity risk premium that currently exists. Secondly, higher borrowing rates will squeeze company margins at a time of record corporate debt rates.
With that said, I believe that furor around the recent uptick in inflation may be somewhat overstated. While inflation has emerged from hibernation, it remains below the targeted 2% range and is still low by historical standards. Equities have traditionally performed well within the 1-4% inflation range. For me, the inflation movement is reflective of an inevitable market function as the economic outlook improves. If we start to approach the higher end of this 1-4% range, then a more targeted inflation protection plan may be needed.
The inflation scare, simply acted as a catalyst for the rotation trade. Many investors were simply waiting for any excuse to push the giant red button, ejecting the out of the some of the big winners and into stocks that arguably have more room to run from a valuation stand point.
If you're hell-bent on inflation protection, base metal commodities will offer strong protection from an inflation surprise, while the financial sector names will likely benefit as the yield curve continues to steepen and credit metrics improve.