We no longer support this browser. Using a supported browser will provide a better experience.

Please update your browser.

Close browser message

Investing

Higher inflation may be here to stay – but will it pose a risk? 

Five takes that explroe the real risk of hot inflation within a strong economy.


Markets in a minute: 5 takes on inflation

 

This week we had markets reacting to an infrastructure investment bill that passed through Congress, world leaders re-affirmed their commitment to climate change mitigation at COP26, and stocks linked to the Metaverse (or an extension of the physical world into 3-D virtual environments) surged. In China, policymakers paved the way toward an historic third term for President Xi Jinping, while Alibaba’s Singles Day generated record sales. Of course, it wouldn’t be a week in financial markets without some drama from Tesla, and Rivian (a new rival in the electric vehicle space) surged to a $100 billion valuation after its initial public offering (IPO). The company is now the world’s second most valuable automaker.

But all of that was drowned out by the inflation data that was released on Wednesday. We have been writing about inflation all year, but here are five updated takes that hopefully can add some context to the debate.

[1] Any way you slice it, inflation is running hot.

October data showed that consumer prices in the United States rose at a 6.2% pace relative to last year, the fastest pace in 30 years. Food prices are 5% higher than they were last year. Used car prices are up 26%. Energy prices are up 30%. Shelter, one of the most critical sub-categories, has rapidly recovered to its pre-COVID 3.5% pace. The gains are broad based, and seem to be accelerating. Compared to last month, the median component is up almost 60 basis points, the highest reading back to 1983.

 [2] Inflation is high because of friction between a booming economy and a continuing pandemic.

The pandemic changed the composition of consumer spending. U.S. consumer spending on goods is more than $700 billion above pre-pandemic trend while spending on services is still $300 billion below pre-pandemic trend. The economy, and especially supply chains, are not equipped to handle this level of spending on goods. The result: price inflation for goods is running at an over 8% pace while services inflation is just 3%.      

 [3] Inflation has its costs, but right now they aren’t damaging the broad economy.

Rising prices pressure all spenders, especially those with low disposable incomes. However, only focusing on rising prices ignores important context. Over the last year, the economy has added almost 5.5 million private sector jobs. Aggregate earnings are up 4% annualized over the last two years versus prices up 3.7%. Retail sales are 15% higher than they were a year ago.

Yes, gasoline prices have soared to $3.40 per gallon relative to just $2.10 one year ago. But gas was also $3.40 per gallon in 2014, when incomes were 25% lower than they are now. The only sector that is seeing any demand destruction because of soaring prices and shortages is automobiles.

Economy wide corporate profits (before tax) are 16% higher. S&P 500 profit margins actually expanded in the third quarter despite expectations for a decline. Input and labor costs are surging, but so are sales. For now, inflation just comes with the territory of a booming economy, and a lower inflation environment would likely also be characterized by a weaker labor market and a more tepid jobs recovery.

[4] Markets are looking through it.

There are compelling reasons why stock markets are still close to all-time highs. Third quarter earnings surprised to the upside, global supply chain pressures seem to be getting better, not worse (Vietnamese factory operations are normalizing and shipping costs are falling), and onerous corporate tax hikes seem increasingly unlikely.

Bond markets are a little more stressed, but given the circumstances, they have been relatively tame. Two-year bond yields have moved up by about 30 basis points since the start of October because investors are starting to think that the Federal Reserve will start raising rates soon in an effort to deal with inflation. Meanwhile, 10-year Treasury bonds are yielding just over 1.5%. Why so low? Simply, because bond markets think that this surge in inflation will be temporary. Longer run inflation expectations are still well below where they were from 2000-2014. 

[5] Inflation isn’t the risk to equity markets. The policy response to inflation is.

Inflation has been strong all year and risk assets have hardly blinked. The mega cap tech sector was often cited as the one that was most at risk during an inflationary environment. The Nasdaq 100 is up over 25% this year.

What could change the picture is if the Federal Reserve makes an abrupt turn toward hawkish policy. And we don’t mean something like accelerating the pace of tapering asset purchases. We mean something like what happened in 1994, when the Fed raised rates by 300 basis points cumulatively because they thought they needed to act quickly to snuff out inflation. Even though corporate earnings grew around 20% that year, equity markets ended flat because cash got more and more attractive.

Another longer term risk is that the discourse around inflation is inherently political. Surging inflation now could make it less likely that policymakers opt for powerful fiscal stimulus during future downturns, which could delay economic recovery and be harmful for stocks.

We have outlined our forward looking view of inflation many times this year (most recently last week). The key is that a shift of spending from goods and back towards services, along with expanding labor supply as the pandemic fades, should mean that inflation is declining towards the Fed’s target in the middle of next year, when they will be deciding whether or not they need to raise rates.

For now, we believe that we are in for a strong growth, higher inflation economy. Stocks should keep benefitting, especially relative to bonds and cash.   

All market data from Bloomberg Finance L.P., 11/11/21.  

Invest your way

Not working with us yet? Find a J.P. Morgan Advisor or explore ways to invest online.   

 

DISCLOSURES

Our Top Market Takeaways for November 11, 2021.

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

Not all option strategies are suitable for all investors. Certain strategies may expose investors to significant potential risks and losses. For additional risk information, please read the “Characteristics and Risks of Standardized Options(Opens Overlay)”. We advise investors to consult their tax advisors and legal counsel about the tax implications of these strategies. Investors are urged to carefully consider whether options or option-related products or strategies are suitable for their needs.

All market and economic data as of November 2021 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

RISK CONSIDERATIONS

  • PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU MAY NOT INVEST DIRECTLY IN AN INDEX.
  • THE PRICES AND RATES OF RETURN ARE INDICATIVE, AS THEY MAY VARY OVER TIME BASED ON MARKET CONDITIONS.
  • ADDITIONAL RISK CONSIDERATIONS EXIST FOR ALL STRATEGIES.
  • HE INFORMATION PROVIDED HEREIN IS NOT INTENDED AS A RECOMMENDATION OF OR AN OFFER OR SOLICITATION TO PURCHASE OR SELL ANY INVESTMENT PRODUCT OR SERVICE.
  • OPINIONS EXPRESSED HEREIN MAY DIFFER FROM THE OPINIONS EXPRESSED BY OTHER AREAS OF J.P. MORGAN. THIS MATERIAL SHOULD NOT BE REGARDED AS INVESTMENT RESEARCH OR A J.P. MORGAN INVESTMENT RESEARCH REPORT.

Check the background of Our Firm and Investment Professionals on FINRA's BrokerCheck

To learn more about J. P. Morgan’s investment business, including our accounts, products and services, as well as our relationship with you, please review our  J.P. Morgan Securities LLC Form CRS and  Guide to Investment Services and Brokerage Products.

This website is for informational purposes only, and not an offer, recommendation or solicitation of any product, strategy service or transaction. Any views, strategies or products discussed on this site may not be appropriate or suitable for all individuals and are subject to risks. Prior to making any investment or financial decisions, an investor should seek individualized advice from a personal financial, legal, tax and other professional advisors that take into account all of the particular facts and circumstances of an investor's own situation. 

This website provides information about the brokerage and investment advisory services provided by J.P. Morgan Securities LLC (“JPMS”). When JPMS acts as a broker-dealer, a client's relationship with us and our duties to the client will be different in some important ways than a client's relationship with us and our duties to the client when we are acting as an investment advisor. A client should carefully read the agreements and disclosures received (including our Form ADV disclosure brochure, if and when applicable) in connection with our provision of services for important information about the capacity in which we will be acting.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

Equal Housing Opportunity logo

J.P. Morgan Chase Bank N.A., Member FDIC Not a commitment to lend. All extensions of credit are subject to credit approval 

J.P. Morgan Wealth Management is a business of JPMorgan Chase & Co., which offers investment products and services through J.P. Morgan Securities LLC (JPMS), a registered broker-dealer and investment advisor, member FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. Certain custody and other services are provided by JPMorgan Chase Bank, N.A. (JPMCB). JPMS, CIA and JPMCB are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.

Please read additional Important Information in conjunction with these pages.