Inflation is not the enemy
According to Siegel, one reason why a pick-up in price pressures right now isn’t bad for stocks is that many publicly traded companies appear to be able to pass on cost increases.
“Because people have so much liquidity, firms have tremendous pricing power. ‘Oh, my God,’ they exclaim. This has increased in price, but I have the funds. ‘I’m paying for it,’ he explained. “As a result, the firms have no trouble covering their costs. This is not like the oil OPEC squeeze of the 1970s, when people didn’t have the money.”
“They [consumers] now have purchasing power. Firms have the ability to set their own prices. They will pass on the price increases, and profits will be much higher,” he added.
Price pressures have been felt throughout the US economy as activity resumes following the coronavirus pandemic-related disruptions.
Siegel has consistently argued that inflation will be more persistent than Federal Reserve officials have predicted, and he has urged the Fed to ease up on its ultra-accommodative monetary policy.
For months, Fed Chairman Jerome Powell and other central bank officials have said that price pressures will be temporary, owing to supply chain bottlenecks and other factors related to the unprecedented nature of the pandemic-era economic recovery.
Because of this viewpoint, Powell has defended the Fed’s easy-money policies, which include near-zero interest rates and at least $120 billion in monthly bond purchases, as appropriate for assisting the labor market’s recovery.
Powell is scheduled to give his semiannual testimony on the state of monetary policy on Capitol Hill on Wednesday and Thursday.
Siegel reiterated Tuesday that the Fed is “behind the curve” on inflation, but predicted the central bank will make an announcement later this month or in August about beginning to scale back asset purchases, a process known as tapering.
The Federal Open Market Committee, the Fed’s policymaking arm, will meet on July 27 and 28. The Federal Reserve Bank of Kansas City will hold its annual economic policy symposium in Jackson Hole, Wyoming, on August 26-28.
While some market participants are concerned about the implications of the Fed changing policy, Siegel believes that tapering bond purchases does not signal the end of a bull market.
“The only thing is if they truly panic,” Siegel said, and end up aggressively tightening policy with a large interest rate hike, for example. “We are miles away from there,” he said emphatically.
The Fed accelerated its rate hike timeline in June, indicating two hikes in 2023, after saying in March that no increases would be made until at least 2024.
Siegel believes the S&P 500 can maintain its strong start into 2021. As of Tuesday afternoon, the broad equity index was up nearly 17% year to date.
“In another six months, we could definitely go up another 10%, 15% unless people really worry the Fed is overreacting, and then we’ll see a correction,” the professor predicted. “It’s difficult to time it, but I’m still in the market.”
Siegel also predicted that the 10-year Treasury yield will end the year above 2%, a prediction shared by others on Wall Street. However, yields have been falling in recent weeks, with the 10-year yield briefly touching 1.25 percent last week. It started the month around 1.58 percent and peaked at 1.78 percent in March.
Shall you buy gold?
According to Mary Nicola, global multi-asset portfolio manager at PineBridge Investments, there is a “better hedge” than gold against rising consumer prices.
TIPS stands for Treasury inflation-protected securities, which are a type of US government bond linked to an inflation measure to protect investors from a decline in the purchasing power of their money.
TIPS investors receive periodic interest payments until the security matures. However, the principal paid to investors upon maturity is either the original amount or an inflation-adjusted amount, whichever is greater.
TIPS, according to Nicola, will perform well when inflation is persistent but temporary.
“We believe inflation will be persistent but transitory, so it is unlikely to persist. But, obviously, because of supply-chain bottlenecks, you’re going to get a few months of high inflation print, possibly even longer than expected,” she said.
Several factors have contributed to the rise in consumer prices in the United States. They include supply chain disruptions, unusually high demand as the pandemic subsides, and comparisons to a year ago, when the economy was still struggling to reopen in the early months of the crisis.
According to fund manager, there is a “better hedge” against rising inflation that is not gold.
According to Jeffrey Gundlach, stocks can remain at “nosebleed levels” as long as stimulus is maintained.
The fund manager discusses her top asset picks for the second half of the year.
The consumer price index in the United States increased 5.4 percent year on year in June, the largest increase since August 2008. The core CPI, which excludes volatile food and energy prices, increased 4.5 percent year on year in June, the largest increase since September 1991.
The effect on gold
The price increase has prompted the Fed to raise its inflation forecast for this year and to move up the date when the central bank will next raise interest rates.
According to Nicola, the change in Fed rhetoric means that the money supply may not grow as much as it did previously. She went on to say that such an environment would be beneficial to gold, which typically performs well when real interest rates are negative.
When inflation exceeds nominal interest rates, real rates fall.
“Since the Fed’s rhetoric has shifted and it has demonstrated that it is less tolerable of negative real rates, money supply will not be as ample as it was previously or growing at the same rate, which should have an impact on gold,” the portfolio manager said.
“As a result, we’ve significantly reduced it.”