Risks To Our Outlook
Though a disappointing employment report helped to support the Fed’s “wait and see” approach to tapering, last week’s surprisingly high CPI readings had the opposite effect. Chair Powell may be forced to make tapering comments if the transitory period of inflation persists.
The debate over tax reform is heating up as both political parties continue to express a willingness to negotiate. Any negativity surrounding these negotiations, as well as the legislative battle for an infrastructure package, will likely create pockets of volatility.
The CDC’s announcement regarding easing safety measures for vaccinated people was welcomed by many. But there is a risk that if more relaxed measures lead to an increase in Covid-19 cases, markets would likely react poorly.
Best Ideas
Improvements in vaccinations and economic reopenings, paired with recent underperformance, makes U.S. small caps particularly attractive. We also remain bullish on emerging markets, as higher inflation readings help the asset class and new Covid-19 cases are plateauing. We continue to favor consumer service sectors, and we are keeping an eye on industrials that could benefit from publicly funded infrastructure investments. Tactical opportunities remain in technology and growth stocks, however with a greater degree of selectivity as the “shelter-in-place” trade may no longer provide a sweeping benefit to all companies.
In Focus: Commodity Inflation Gyrations
Commodity prices have increased sharply since the 2020 pandemic-driven lows. The supply of agriculture products, metals, lumber and basic chemical products had all been curtailed in anticipation of a large reduction in demand that never materialized. In fact, demand actually rose in some cases, such as lumber and paint for residential construction and DIY projects. We are now seeing spikes in inflation data that have led to increased market volatility.
Demand for certain commodities will likely remain high due to a variety of idiosyncratic circumstances, such as high growth levels of Chinese livestock that consume large amounts of agricultural goods or the growth of electric vehicles that require the use of specialty metals. Additionally, prices may remain elevated in some cases due to inherently slower “restocking” processes, such as in soybeans and corn. Overall, however, we expect the effects of commodity-driven inflation to be limited.
In this environment, we think it is critical to focus on underlying supply and demand trends for each commodity to judge the pace of ‘normalization’ as economies begin to reopen. Though the magnitude and duration of this inflation spike may be greater than originally anticipated, it should ultimately prove transitory. These pricing pressures should dissipate as supply chains recover and discretionary income shifts away from goods and commodities toward services and experiences, leading to a cooling of peak spot prices and a reduction in equity market volatility.
Saira Malik is head of global equities at Nuveen.