Macro Minutes: Inflation and the 3-Month Rule

Video title screen appears, "Macro Minutes: Inflation and the 3-Month Rule"

Face Cam on the bottom right showing a man wearing a suite

Luke Puetz: Hello, my name is Luke Pitts. I'm a Capital Markets analyst, and today I'm going to be talking about inflation and the three-month rule.

Screen shows a line chart of “US HEADLINE CPI GROWTH AND S&P 500 BEAR MARKETS”

It indicates that CPI growth goes up and down beginning from 1998

It is at nearly 2% and up close to 4% in between 2000 and 2002, then it goes down close to –2% between the year 2008 and 2010. Then it keeps jumping up and down over the years.

Luke Puetz: Inflation has been a hot topic for much of 2021. US. CPI growth is the highest in years, and many investors have expressed concern. This inflationary bout could intensify.

For an equity investor, inflation can be a red flag. As this chart illustrates, high inflation sometimes coincides with the early stages of bear markets.

Luke Puetz: However, bear markets do not always follow inflationary periods as witnessed in 2005, 2011 and 2016. In the current circumstance, we believe today's inflationary conditions are most likely a short term condition associated with reopening of the economy, and many other bear market symptoms, such as widespread euphoric sentiment towards stocks, are not present.

Screen shows a line chart for "US MANUFACTURING AND NON-MANUFACTURING PMIS”

It indicates the economic growth “ISM” and “PMI” over the years starting from the year 1998 to 2020.

Luke Puetz: Observing PMIs, which are surveys illustrating the pace of economic growth, helps place the current inflationary jump in context. Since the March 2020 COVID Lockdowns, the pace of economic activity has persistently accelerated, particularly following the vaccine announcement in November.

Luke Puetz: In recent months, the US. Has experienced the fastest pace of growth in decades. In general, the demand side of the economy can move much faster than the supply side. If the supply side misjudges the future trajectory of demand growth, shortages can develop. In the current instance, that appears to be affecting several industries, most notably semiconductors.

Luke Puetz: Consequently, surging prices in new and used automobiles. The industry most affected by the current semiconductor shortages have been a large driver of US Price gains. However, we believe the rapid pace of demand growth associated with economic reopening is mostly an old story, and moving forward, a decelerating pace of growth alongside increasing production is likely to ease supply side constraints.

Screen shows a bar chart titled “INTRA-PARTY GRIDLOCK” for Historical Democratic Party control of the US Congress starting from 1921 to 2021.

The chart contains dark blue bars along with light blue charts.

Luke Puetz: An additional perceived risk for the inflation outlook is the potential passage of the two infrastructure packages in the US. Congress totaling roughly $4 trillion. While we acknowledge large fiscal expansion is a potential inflationary risk, we doubt high fiscal expectations will materialize.

Luke Puetz: The dark blue bars in this chart show historical Democratic Party control of the US. Senate and the US. House of Representatives, while the light blue bars show periods with Democratic presidents. Throughout modern history, new Democratic presidents have entered office with sizable advantages in both houses of Congress.

Luke Puetz: Democrats dominated Congress when they passed FDR's New Deal in the 1930s and LBJ's Great Society in the 1960s. One of the unique conditions of the new Biden administration is razor thin margins in both houses of Congress. Consequently, we expect that the centrist wing of the party is likely to dampen the scope of future legislation relative to current expectations.

Screen shows a line Chart for S&P 500 (1998-2010) With illustration of slow-rolling tops. The chart Contains one line starting from 1998 going up and down to 2010, and at the right hand side it starts from the bottom at 600 up to 1600 in S&P 500 price return

Luke Puetz: Of course, we could be wrong about inflation, and maybe this episode is an end of cycle symptom. If so, an advantageous feature of bear markets is they usually sneak up on you slowly with a rolling top. This feature contrasts with corrections within bull markets, which often begin with sharp, scary declines.

Luke Puetz: Because losses tend to be minimal early in bears, about 2% per month. We can patiently wait until at least three months have passed since the prior market peak before shifting strategy towards a more defensive positioning. We call this the three month rule. As this chart helps illustrate, most bear markets experience the greatest losses in the later stages of bear markets.

Luke Puetz:  In contrast, the red dots show minimal losses from the peak through the first three months of the bear. As of late August, the market is continuing to hit new highs. Further, recent market highs have occurred outside of the Euphoric environment as investors worry about the delta variant and Fed tapering. We believe the current episode of inflation is likely to fade as the pace of economic growth normalizes. But if we are wrong, we will keep our eyes open for other bear market symptoms in a slow rolling top.

A message appears on the screen: “Thank you for watching! If you would like to learn more about our views, please reach out to your relationship manager or email FisherInstitutional@fi.com” with a man using face Cam at the bottom right

Luke Puetz: Thank you for watching! If you have any questions, please reach out to your relationship manager.

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