S&P 500 Index to advance nicely towards 4500 by end-2022, defying inflation risks – CE

Equities have nearly always struggled when inflation has been very high. According to BofA ML’s widely followed survey of global fund managers, inflation is now considered to be the greatest “tail risk” to markets, ahead even of the pandemic taking another turn for the worse and asset price bubbles. Are they right to be so concerned? Oliver Jones, Senior Markets Economist at Capital Economics, evaluates the inflation risk to US equities.

Higher inflation to be a problem if it is accompanied by a substantial deterioration in the outlook for real growth

“The data do not support the idea that equities are bound to struggle if inflation is higher than over the past decade and inflation expectations increase a bit further. Higher inflation would be a problem if it were accompanied by a substantial deterioration in the outlook for real growth, and/or a sharp tightening of the real stance of monetary policy. But we do not expect that to happen soon, even though our inflation forecasts are above consensus.”

“While supply constraints in some sectors are contributing to the increase in inflation, overall we are still anticipating a strong rebound in activity as re-opening continues and fiscal policy remains supportive. Meanwhile, Fed officials are making it clear that they have no intention of tightening prematurely, emphasising that they view the current increase in inflation as transitory, and that they are willing to tolerate a period of above target inflation. If a ‘Volcker moment’ is coming, it still appears to be a long way off.”

“We still expect the S&P 500 to make some more headway over the next couple of years (albeit much less than over the past year or so given its valuation). Our end-2022 forecast is 4,500, compared to 4,159 today.”

“We are expecting the composition of gains in the stock market to be very different to the low-inflation, low-growth environment of the 2010s. We have made the case that the tech and growth stocks that thrived over the past decade are more likely to lag than lead the market if inflation is higher and growth a little faster, and that other areas where the Biden administration is seeking to change policy, including corporate tax and antitrust, may also push in the same direction.”