Protection from Inflation - Holdun

Market Summary

Sector rotation across the major US equity indexes took hold this week. A broadly upbeat fourth-quarter earnings season had powered Wall Street’s main indexes to record highs earlier in the week, but fears over an imminent inflation surprise dampened this enthusiasm as the week drew to a close.

Higher than expected CPI and Retail sales figures in January coupled with the pending $1.9 Trillion support package is positive news in terms of an economic recovery but gave rise to fears over a faster than expected reinflation timeline.

This prospect of rising inflation triggered caution over lofty equity valuations, hitting shares of high-flying technology-related companies. The COVID favourites, including Microsoft, Facebook, Alphabet’s Google, Netflix and Amazon, fell as investors looked to bank some of the gains made since last March. Investors opted instead for cyclical stocks set to benefit from pent-up demand as the economy re-opens.

Over the week, the Dow rose 0.1% while the S&P 500 fell 0.7% and the tech-heavy Nasdaq slid 1.6%.


0.7%S&P 500

As mentioned, value stocks outperformed growth in an unwinding of last year’s underperformance. Small-cap stocks suffered the opposite fate as the small-cap resurgence was interrupted, falling 1% for the week but remains up 50% since the end of September 2020. Emerging market equities continue to outperform developed markets with 7% outperformance YTD as China, Taiwan, and South Africa boosted returns.



The Dollar slip continued this week as the same factors pushing yields higher have pushed the dollar lower. Dollar devaluation resulting from continued FED printing and expectations over higher inflation has resulted in the greenback remaining out of favour for investors.

Bond Yields


The yield on the 10Y treasury jumped to its highest point since February 2020 as Congress remains poised to act on a massive fiscal stimulus package and inflation expectations pick up.



Cryptocurrencies appeared to remain the preferred choice of those betting on dollar devaluation, with bitcoin ending the week above $55,000 per coin as gold hits a seven-month low.



Market Outlook

This week, market conversations were dominated by the re-emergence of inflation, with longer-term bond yields jumping to their highest point in a year. The idea that higher than expected inflation could negatively impact stock market performance was the major talking point. While I understand where the argument is coming from (any rise in bond yields will negatively impact the equity risk premium that currently exists), I believe that furor around the recent uptick in inflation may be somewhat overstated. While inflation has emerged from hibernation, it remains below the targeted 2% range and is still low by historical standards. Equities have traditionally performed well within the 1-4% inflation range. For me, the inflation movement is reflective of an inevitable market function as the economic outlook improves. If we start to approach the higher end of this 1-4% range, then a more targeted inflation protection plan may be needed.

For those looking to protect their portfolio sooner rather than later, base metal commodities will offer strong protection from an inflation surprise, while the financial sector names will likely benefit as the yield curve continues to steepen and credit metrics improve.