The Impact Of Inflation And The Fed On Indices And Corporate Bonds

CalibratedConfidence's picture

Everyone's talking about the Federal Reserve's exit strategy and whether rates will increase before or after it contracts its balance sheet. A major topic is inflation, and specifically the most recent increases in the Consumer Price Index (CPI) on a year over year basis.

When listening to the chatter, remember that these increases are nothing in the context of history. Actually, the recent CPI increases benefit the S&P 500 and is very bullish for certain sectors.

Since 1948, inflation has averaged a growth rate of 3.6 percent. According to the April data, inflation currently floats around two percent.

Some Twitter and TV stars have pointed to the rapid jump in inflation recently as a sign of trouble and a signal for lower economic growth, implying the Fed will stay around or at least alter its "exit strategy". What these commentators are missing is the fact that the economy has enjoyed a very steady and low-level of inflation over the past 25 years.

Market Fears

The new fear in the markets is how high and how quickly inflation will grow.

So long as inflation stays under four percent, it's a bullish factor. In such environments, the S&P 500 (since 1948, according to S&P's Capital IQ) increases on average 70 basis points per month. The increase reflects investors' desire for exposure to a growing economy alongside accepting exposure to higher inflation.

If inflation increases past a certain point, the correlation reverses, with higher inflation indicating a decreasing S&P 500. Historically the line in the sand for this analysis comes at four percent Annual CPI Change. After four percent, the S&P 500 returns have become negative on a monthly basis.

Sam Stovall, Capital IQ's US Equity Strategist for Global markets Intelligence, writes in his most recent release that, "during periods of rising inflation....the Energy, Info Tech, and Materials sectors held up best, while Consumer Discretionary, Financials, and Telecom Services were hit hardest".

As Benzinga CEO Jason Raznick hinted in a recent article, the reallocation of capital from traditional markets to other asset classes poses a risk to investment, especially as capital runs into the Leveraged Loan market, and avoids the corporate bond market.

In this period of low rates, corporate bond activity has increased for certain speculative-grade debt.

When the Fed finally does move away from its Zero Interest Rate Policy (ZIRP), there may be a pause in corporate debt issuance resulting in higher issuance costs which could be detrimental to credit markets.

Stovall also noted that the increase in companies with negative outlooks or CreditWatch negative ratings compared to those with positive outlooks or CreditWatch positive ratings will be the reason for downgrades becoming more common than upgrades in the coming quarters.  This will drive up interest payments which are already hovering around 11-13 percent of EBITDA profits as default rates fall toward 2008 lows.

The current environment is still beneficial on a monthly basis. To the long-term investor it would appear, though past performance is not a guarantee of future performance, one could formulate a plan for the coming few months.  The pump fakes will come from the Fed as they prep the market to digest the Fed's desire to increase rates and shrink its balance sheet.

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ebworthen's picture

"What these commentators are missing is the fact that the economy has enjoyed a very steady and low-level of inflation over the past 25 years."

What the author is missing is that the FED and .gov publish fake inflation figures so they can continue to fleece the populace for the benefit of banks while debasing the currency.

The entire economy is a Ponzi scheme. 

"EBITDA" and "Bullish" = Bullshit.

Seeking Aphids's picture

great post O! This helps explain the inflation/deflation conundrum.

OC Sure's picture

Thank you very much!

Please see tomorrow.

I am writing a more detailed explanation and the intent is that it make my point irrefutable. We'll see.

CapitalistRock's picture

In my opinion you are confusing inflation with the CPI. Starting in the 1990s the CPI became primarily a propaganda tool. If you use it for economic analysis you will be led astray.

orangegeek's picture

Deflation - that's why the Fed/gov is pushing so hard the other way.


Deflation is here and has been here for years.


Concentration of wealth accelerates deflation's devastating effects - it's called a depression.


Upside in the S&P is driven by Fed purchasing aligned with Bank/Hedge purchasing.


It's like two rugby players lateraling the ball back and forth running up and down the field while everyone else in the stadium - including other players, stands and watches and then eventually leave to go somewhere else.


The Fed has taken a system that was of interest and turned it into a circus and the MSM and gov pumps this circus with BS data and fluff reporting.



OC Sure's picture

Deflation is exactly what productive workers should desire.

Again, deflation of what?

Increased purchasing power of a currency means that there is a reduction, a deflating, of theft; that productive workers are keeping more of what they earn.

Modern economics is facilitated by thieves and it is always the thieves who are disseminating the lies. They say deflation is bad and inflation is good.

Bad and good for whom???

AdvancingTime's picture

Never before has mankind diverted such a large percentage of wealth into intangible products or goods.  I contend this is the primary reason that inflation has not raised its ugly head or become a major economic issue.

 The modern economy that has evolved over the last several decades is loaded with interwoven contracts reeking of contagion. If faith drops in these intangible "promises" and money suddenly flows into tangible goods seeking a safe haven inflation will soar.

The timetable on which economic events unfold is often quite uneven and this supports the possibility of an inflation scenario. A key issue being one of timing. If the price of gas jumps to $8 a gallon overnight do you buy gas and not make your car payment or stop driving the twenty miles to work? Answer, it could be months before your car is repossessed so you buy gas.

It is important to remember that debts can go unpaid and promises be left unfilled. Is this possible and if so where would that leave us? Chaos and major disruption would result from such a scenario. As we have seen from the economic crisis of 2008 and following many other unsettling developments legal actions can continue to drag on for years.  More in the article below.

OC Sure's picture



Inflation of what? ...inflation of currency.

Currency is EITHER money OR counterfeit but it cannot ever be both.

If money is inflating then the currency's purchasing power is increasing.

If counterfeit is inflating then the currency's purchasing power is decreasing.

Please don't let the tyranny of modern economics describe the terms. Using the precise defintion of terms enables the uninformed to quickly see that:

Money comes from productive work; Counterfeit comes from theft.

"...It is this exchange of counterfeit that lowers the producers' power to purchase. Whomever receives the counterfeit first trades it for the products of other people's work. As the counterfeit is passed along its power to purchase decreases and what one would have purchased with the higher power to purchase before the counterfeit was introduced has been stolen from them by the thief. The repeated process of introducing more and more counterfeit into the economy necessarily then represents the increasing theft of the purchasing power from those who do productive work by those who do not. Counterfeiting therefore is the primary cause of the atrophy of the middle classes as they are surreptitiously pummeled into poverty. Such is the corrupt nature of modern economics and how well established thieves steal from producers..."