Inflation worries bolted to the forefront last week, forcing stocks from their record highs. However, by the week’s end, inflation worries cooled, and equities responded, reducing the damage caused to indices earlier in the week. The TSX pulled back 72 basis points in the week but remained up 10.49% year to date. The S&P 500 dropped 1.39% during the week, and the year-to-date gained a respectable 11.12%. The tech sector was the big loser, with the Nasdaq losing 2.34% last week, but remains in positive territory for the year-to-date at a modest 4.2% gain. The Mid Cap S&P 400 and the small-cap Russell 2000, which showed leadership earlier in the year, slipped 1.75% and 2.07%, respectively. Both indices are positive year-to-date at 18% and 12.65%.
Elon Musk’s announcement that Tesla would no longer accept cryptocurrency in payment produced a sell-off in both the cryptocurrency market and the consumer discretionary sector. Mid-week, the Nasdaq was off 8.5% from earlier April highs but still above the 10% threshold to be considered a correction.
The Labor Department release on inflation shocked market participants with worries of a US Federal Reserve response, and that inflation may not be as transitory as the Fed is suggesting. Inflation accelerated at the fastest rate in over 12 years, jumping 4.2% from a year ago. The expectation was for a more modest 3.6% increase. The March 0.8% increase was the big surprise compared to the surveyed number of 0.2%. Core inflation, excluding energy and food prices, increased 3% over a year ago and .9% monthly compared to the estimates of 2.3% and 0.3%. Energy prices were up 25% from a year ago, with prices at the pump up 49.6%. Having dropped slightly in April, gasoline resumed moving higher in May, with the national average breaching $3 a gallon, the first time since November 2014. Also, used car and truck prices jumped 21% year-over-year with a 10% increase in April alone. As the re-opening continues, many are abandoning public transportation for health reasons, increasing the demand for personal transportation.1 The surge in inflation was within the goals while a surprise to the federal reserve members. They continue to believe the recent surge in inflationary pressures is transitory and within the target range. As stated many times in the past, the employment picture is more worrisome.2
Wage inflation is one of the primary drivers of the general inflation measures. To date, wage pressure is modest, but this could be about to change. As mentioned in last week’s commentary, the unintended consequences of additional federal unemployment benefits and extension could be one reason for the weak job report in April. The NFIB released the Small Business Optimism Index on Tuesday for April, which increased by 1.6% from March, coming in at 99.8 for April. Over the last three months, the measure is up 4.8 points. The cause for concern in the report is that 44% of the owners of small businesses report job openings going unfilled. On a net basis, 31% reported raising compensation while 20% plan to increase wages over the next three months. Quality of labor was the top business problem reported by 24% of businesses.3 The NFIB report is available here.
On Thursday, the US Labor Department reported the initial claims for the week ending May 8 at 473,000, a decrease of 34,000 from the previous week’s upwardly adjusted 507,000. Continuing claims for all programs jumped 696,152 from the prior week totaling 16,855,264 compared to 21,863,056 last year this time.4 Currently, it is reported that 9.8 million are unemployed, fewer than the 16 million-plus on benefits; the difference being those who have dropped out of the workforce and no longer looking for a job.5 Eleven states have announced they will no longer participate in the federal government’s supplemental unemployment benefits program claiming the increased benefits and extension to September disincentivizes workers to search for jobs. The addition of 266,000 jobs in April (compared to an expected one million-plus) and the latest small business concerns over unfilled job openings support the contention that the federal government supplemental benefits may be slowing the economy re-opening. Supply chain disruptions are causing several industries to slow production due to a lack of critical components.
Optimism for economic growth for the remaining part of the year continues to be robust. At the same time, the expectations for equity markets, driven by earnings, are not as strong due to inflationary cost pressures for components and labor.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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