Fed must allow correction if wrong on inflation
GlobalCapital, is part of the Delinian Group, DELINIAN (GLOBALCAPITAL) LIMITED, 4 Bouverie Street, London, EC4Y 8AX, Registered in England & Wales, Company number 15236213
Copyright © DELINIAN (GLOBALCAPITAL) LIMITED and its affiliated companies 2024

Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement
People and MarketsCommentGC View

Fed must allow correction if wrong on inflation


The US Federal Reserve’s market liquidity measures have provided the fuel that has propelled stock markets to new highs. But its core mandate is to fight inflation and unemployment, not to line the pockets of stock investors. If the central bank is wrong about the “transitory” nature of the recent spike in inflation, then it must act.

After an initial tumble, equity markets rose to gargantuan heights during the Covid-19 pandemic, notwithstanding the carnage wrought on the global economy by lockdown measures, with tech stocks being the major beneficiaries of a flood of investment.

It seems incredibly unlikely that investors would have flocked so enthusiastically to the stock market, were it not for increased liquidity injected by the Fed.

Now, large scale vaccination programmes across developed markets are causing spikes in underlying economic growth, intensifying concerns about inflation and calling into question the relative value of tech companies whose stocks have been bid into the stratosphere.

Last week, US Consumer Price Index data shot past consensus forecasts of 3.5% to hit 4.2%. Investors sold equity on the news, but fears over inflation had already caused some to abandon the tech positions they had favoured during the pandemic.

It may have made sense to increase allocations to equity with other asset classes yielding very little, if anything, but the revenue multiples at which stocks have been trading look ever more tenuous.

Even Amazon, one of the most successful moneymakers in the world, is trading at more than 60 times its revenue. This could be forgiven in a high growth tech firm likely to capture a nascent market, but Amazon already owns most of global retail and the cloud. Are there any uncharted waters in which it can grow its revenues to justify such a multiple?

And even those tech firms that actually are in high growth sectors are deemed by many to be trading way above where they should be.

The ARK Innovation ETF, a vehicle which tracks some of the most highly valued tech stocks, has fallen by more than 30% since mid-February.

As investors prepare for yields to climb, the relative appeal of certain stocks fades away, especially because their valuations are not fundamentally sound.

The Fed has attempted to settle markets by saying it believes the spike last week is a sign of “transitory” inflation. But if it isn’t, and the CPI print is a sign of longer lasting price rises, then the central bank must act to counter them.

And there are facts that would support the conclusion that inflation will indeed be persistent. The phase-out of lockdown measures has created a boost in demand that is now being supercharged by economic stimulus from the Biden administration.

Investors have already begun selling equity positions to prepare for inflation. If those core numbers continue to grow, then the Fed needs to let the market correct this time, despite the short-term pain for equities.

Gift this article