Last piece in the puzzle

Major US indices traded mixed on Monday. Technology stocks lagged, while energy and mining companies led gains in New York. 

The common denominator in the Nasdaq’s fall and the S&P500’s rise was the revived inflation worries among investors. Warren Buffett’s recent warnings about the ‘red-hot’ economy has certainly brought the hidden inflation worries forward.  

Even though the Federal Resevre (Fed) insists that its ultra-supportive monetary policy is just what the US economy needs right now, the macroeconomic indicators should soon put the Fed in a difficult position. We can now see the storm approaching.  

So far, the US companies posted strong first quarter results, some 90% of the S&P500 companies that have reported results so far beat analyst estimates. The US posted a robust 6.4% growth in the first quarter last week. Inflation is knocking loudly at the door. Not only that the jump in producer prices have started reading through consumer prices, but the skyrocketing commodity prices from lumber, to copper and to soja, and the global chip shortage, combined with the delays in worldwide logistics point that the situation is just about to get more serious in terms of inflation.  

The last piece in the puzzle: Substantial progress in US jobs 

Inflation is something that the Fed is relentlessly talking down, as the focal point of the US policymakers remains the US jobs market, where they want to see a ‘substantial progress’ happening. And that’s the last piece in the puzzle would be another month of ‘substantial progress’ in the US jobs figures on Friday. 

Because, at some point, the combination of strong earnings, robust economic growth, rising inflation and improved jobs market should revive the Fed hawks and shaken the market dynamics. 

And the expectation of an NFP figure just shy of a million should give a stronger case for a further migration from growth to value stocks ahead of the US jobs data. 

So this year’s ‘Sell in May and Go Away’ could hit the technology stocks harder than the cyclical names. The higher the valuations, the steeper the downside correction. 

Energy and mining stocks are in a good position to benefit from the reflation trade, as they are a natural hedge against the rising inflation. Moreover, the first-quarter earnings from some leading energy companies like BP and Exxon Mobil are encouraging. There are two more things that justify a higher portfolio allocation in energy. First, energy companies’ stock prices lagged behind the overall market. Therefore, even if we see a further retreat on the index level, these companies are left potential for further recovery. Second, investors are much less demanding in terms of the energy company earnings for now, which gives them an additional potential for beating expectations for the coming quarters. 

A relatively stable British pound below the 1.40 against the US dollar, firm energy, commodity prices, and the reflation theme should help FTSE 100 catching up on its delay in the coming quarter.  

Activity in FTSE futures hint at a positive start on Tuesday. It is just a matter of time before we see the bank-and-energy-heavy FTSE taking the 7000p resistance out sustainably.