Inflation Worries. Prices are rising there is no doubt about that fact. I pointed out that inflation was rearing its head a few months ago as the breakeven inflation rate rose above 2% after plunging during the COVID-19 pandemic. Today, news headlines are talking about inflation more and more. The average consumer is worried about inflation. Inflation reduces your buying power due to rising prices. The same dollar a few years ago buys less today. The U.S. Federal Reserve is also worried about inflation.
Inflation Expectations and Worries
In March, the U.S. Federal Reserve indicated that it saw no rate hikes at least until 2024. That outlook has changed. The so-called dot plot of individual member expectations now indicate that a rate hike could come as soon as 2023. But the Federal Open Market Committee (FOMC) did not change its benchmark short-term borrowing rate, which is still near zero.
The Fed also raised its inflation expectations to 3.4% in the June meeting, which is a full point higher than at the March meeting. Stock fell in response and had the worst week since October 2020 because this change was not expected.
The change in outlook has more immediate implications though since it means that the Fed will need to taper its bond buying purchases of $120 billion per month perhaps by end of 2021 or early 2022. If inflation stays elevated the taper could occur earlier. The new stance by the Fed also does not coincide with the view that the spike in inflation is temporary, and that the long-term inflation rate is 2%. But what if the Federal Reserve is wrong? I asked that question in my article in February and it seems like for good reason. The Fed was too conservative in its expectations.
Why Is Inflation High?
The bottom line is that the U.S. economy is growing quickly, which is a good thing. The Fed now sees the Gross Domestic Product growing at 7% in 2021 changed from earlier expectation of 6.5%. The Fed’s unemployment estimate is still 4.5%. The U.S. economy is expanding at the fastest rate since WWII. Some of this is due to the rebound from the steep COVID-19 downturn and some due to record stimulus during the pandemic.
Businesses increased liquidity and consumers saved money during the pandemic and that money is now being used. We are likely getting more stimulus in the form of the semiconductor stimulus bill and an infrastructure bill. This growth is coming at a cost though as prices are increasing at the fastest pace in 13 years leading to inflation worries.
Consumer prices increased 4.2% in April, which is the fastest rate since September 2008, and was higher than expectations of 3.6%. Some of this can be traced to rising gas prices, used car prices, and rents. The prices of these three items declined during the COVID-19 and are coming off a low base. Key input materials such as lumber, copper, tin, oil and other commodities are also experiencing higher prices. We also cannot forget the cost of tariffs implemented before 2021, which have the effect of raising prices.
Final Thoughts on Inflation Worries
Should you worry about inflation? Probably not as there is little you can do to control it. But if the U.S. economy continues to run hot with high growth and an inflation rate that is higher than desired it will lead to tapering and eventually a rise in interest rates. Already, some countries have raised interest rates and there may be more hikes to come if inflation stays elevated. A rise in interest rates would mean that your savings accounts and CDs may pay more. But it could also lead to some short-term volatility in the stock market as expectations change. If you are worried about inflation protection, then gold is the classic hedge against inflation and Treasury Inflation-Protected Securities (TIPS) are also available. However, I am not worried about inflation and personally I am not changing my focus on dividend growth stocks.
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Chart or Table of the Week
Today I highlight a Bank of Nova Scotia (BNS), which is one of the big four Canadian banks. The bank is one the few stocks that has paid a consistent dividend for 100+ years. The bank along with the other large banks are popular investments for Canadians. The Bank of Nova Scotia can also make a good investment for those looking to diversify out of U.S. stocks. The current yield is 4.5% and the payout ratio is a conservative 46%. The stock trades as an ADR on the NYSE. The screenshot below is from Stock Rover*.
Dividend Increases and Reinstatements
I have created a searchable list of dividend increases and reinstatements. I update this list weekly. You can search for your stocks by company name, ticker, and date.
Dividend Cuts and Suspensions List
I updated my dividend cuts and suspensions list at end of April. The number of companies on the list has risen to 523. We are well over 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic.
There were two new companies to add to the list this past month. These two companies were HollyFrontier Corporation (HFC) and AT&T (T).
Dow Jones Industrial Averages (DJIA): 33,291 (-3.45%)
NASDAQ: 14,030 (-0.28%)
S&P 500: 4,166 (-1.92%)
Market Valuation – Inflation Worries
The S&P 500 is trading at a price-to-earnings ratio of 44.3X and the Schiller P/E Ratio is at about 37.0X. These two metrics are down this past week. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively.
I continue to believe that the market is overvalued at this point. I personally view anything over 30X as overvalued based on historical data. Note that we are near or over 40X and valuation levels near the top of the dot-com era.
S&P 500 PE Ratio
Shiller PE Ratio
Stock Market Volatility – CBOE VIX
The CBOE VIX measuring volatility was up about four points this past week to 20.70. The long-term average is approximately 19 to 20.
Fear & Greed Index
I also track the Fear & Greed Index. The index is now in Fear at a value of 30. This is down 24 points this past week.
There are seven indicators in the index. They are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.
Junk Bond Demand is indicating Greed. Investors are accepting 2.03% yield over investment grade corporate bonds. The spread is down further from recent levels indicating that investors are taking on more risk.
Market Volatility is set at Neutral. The CBOE VIX reading of 20.70 is a neutral reading.
Put and Call Options are signaling Fear. In the last five trading days, put option volume has lagged call option volume by 55.47%. This is amongst the highest level of put buying in the past two years.
Market Momentum is indicating Fear. The S&P 500 is 4.44% over its 125-day average. This is further above the average than normal over the past 2-years.
Stock Price Strength is signaling Extreme Fear. The number of stocks hitting 52-week highs compared to those hitting 52-week lows is at the lower end of its range.
Stock Price Breadth is indicating Extreme Fear as advancing volume is 10.43% more than declining volume on the NYSE. This indicator is near the upper end of its range over the past two years.
Safe Haven Demand is in Extreme Fear. Stocks and bonds have similar returns over the past 20 trading days. This is close to the weakest performance for stocks over the past 2-years as investors move back into bonds.
The US Census Bureau reported retail sales fell 1.3% in May to $620.2 billion, ex-autos, gasoline, building materials, and food services retail sales dropped 0.7%. May 2021 figures are 28.1% higher than May 2020. For the period March to May 2021 U.S. retail and food services sales were up 36.2% over the same period in 2020. April 2021’s MoM retails sales were revised up from 0.0% to 0.9%. In addition, the April retail sales ex-autos figure was revised up from -0.8% to 0.0%. Retail trade sales were reported down 1.7% from April 2021 but are up 24.4% compared with April 2020. Clothing and clothing accessories stores sales were up 200.3% and food services and drinking places were up 70.6% versus May 2020.
The U.S. Bureau of Labor Statistics reported the US producer price index up +0.8% in May, after increasing 0.6% in April. The U.S. PPI is up 6.6% for the 12 months ending in May, the fastest rate since November 2010 and follows a brisk 6.2% increase in April. The Core PPI, which excludes the more volatile food and energy prices, was up +0.7% month-over-month and +4.8% for the 12-month period ending in May. Nearly 60% of the increase in the index for final demand is attributed to a 1.5% rise in final demand goods pricing, after rising 0.6% in April. Prices for final demand foods were up 2.6% and for final demand energy 2.2%. The final demand services index reported up +0.6% in May, the fifth consecutive increase. Over 40% of the increase in the index for final demand services is attributable to margins for automobile retailing, which increased 27.3%.
The U.S. Census Bureau reported new residential building permits were down 3.0% in May to a seasonally adjusted 1.681M, still some 34.9% above the May 2020 rate of 1.246M. Single-family permits were down 1.6% over a revised April figure of 1.148M. Privately-owned housing starts were up 3.6% to 1.572M, 50.3% above the May 2020 rate of 1.046M. Single-family housing starts were also up, coming in at 1.098M, 4.2% above April’s revised 1.054M. Privately-owned housing completions reported at 1.368M, down 4.1% from April, and up 16.1% over May 2020.
Thanks for reading Inflation Worries – Week in Review!
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.