Stocks endured their worst week since June last week after a US Bureau of Labor Statistics report showed inflation running at 8.3%, far above the central bank’s 2% target.
A particularly disappointing fact about the report was that measures of trend inflation, which smooth out temporary effects, showed no signs of improvement. The Cleveland median CPI increased 0.7% month-on-month and 6.7% year-on-year,
while the New York Fed’s Underlying Inflation Gauge shows trend inflation is running at 5-6%.
After the publication of the inflation report, interest rates increased. Some now predict that the Federal Reserve will have to increase rates by 100 basis points this week.
Because inflation has proved persistent, there is a chance interest rates will have to move much higher, to the 5-6% range.
This leaves the stock market in a vulnerable position. Morgan Stanley notes that “When in June the real 10-year US Treasury interest rate approached 1%, prices were 5.3% lower and risks of global recession were lower, too.”
In addition, earnings estimates appear too high, while economic uncertainty remains elevated.
Putting all the various problems the market faces together, we find stocks unattractive at current levels and thus hold the majority of the portfolio in cash. Cash is “one of the few assets where expected returns are going up,” and “we are ‘paid to wait’ for [a] better opportunity,” is the way Twitter’s MrBlonde puts it.