Last month we suggested that the chance for some stock market volatility had increased as our market sentiment indicator was flashing a warning sign. While May started out strong, we saw some volatility as the market pulled back in the middle of the month before bouncing back and finishing the month roughly where we started (YCharts).

The primary concern that grabbed headlines this month was inflation.  This risk has become front and center as we continue to see a strong economic recovery, historic fiscal and monetary stimulus, and a much stronger than expected earnings season.

Inflation sounds scary – the potential for higher prices on everyday items leads us all as consumers to worry about whether we can continue to enjoy the same standard of living that we do today. That fear is understandable; however, we believe it’s important to clarify what type of inflation we are expecting to see. 

We would break inflation into 3 broad categories: low inflation (in the 2% range), rising inflation (2-4%), and higher inflation (4%+). The first two kinds of inflation are not overly concerning, but certainly warrant watching. In fact, stocks (as an asset class) generally perform well in the first two categories. (Schwab) The question that we need to answer is whether or not we expect to see inflation overheat?  While we are seeing some inflationary pressures, we feel it’s too early to declare that we’re seeing runaway inflation. 

We are going to outline a few items that we will be watching and considering carefully as we monitor the inflationary environment.

• Base Effects: Inflation data is expected to be alarming over the next few months – don’t panic.  Part of the reason for this is that the year-over-year data compares the current period to the sudden economic shutdown 1 year ago, likely resulting in some unusual numbers.
• Could Inflation be transitory?  The Fed has suggested that this may be the case. In this scenario we would see inflation pressures recede as a number of temporary drivers (including recent supply chain problems) are resolved.
• Labor Market: The unemployment rate is still above 6% which could help keep wage pressures in check for the time being.  This, combined with the lower labor force participation suggests that there is some slack in the labor market.  This slack could help keep labor costs, a major source of inflation, down.

Rising rates and some inflationary pressures are not catching us off guard.  Coming into this year we had already made some adjustments to the fixed income side of the portfolio.  By reducing the duration (shorter maturity) of our bond portfolio we aimed to mitigate the impact of rising rates.  So far, that has been beneficial. 

We will continue to watch portfolios carefully, and will be ready to make changes to our positioning as the inflationary environment evolves.

Sincerely,

Your Team at TLWM

*Investment advice offered through TLWM, LLC., a registered investment advisor.

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