Relatively tame inflation data, a pullback in commodities, and continued dovish comments out of the Federal Reserve have all led to a growing feeling among investors that the big jump in inflation may be transitory after all. We have watched the bond market closely for the past two months to see if another leg up in interest rates was imminent. Rates have held steady despite equities moving higher and all sorts of talking heads claiming that raging inflation is on the way. The fact that rates have held within early March levels (and even dropped) is strong evidence that the rapid rise in interest rates associated with the economy reopening was priced in months ago. We have discussed many times over the years that the bond market is one to watch. I believe the big and smart money plays in that pond. Stocks just tag along.
From here, I suspect bond yields will rise gradually as growth gathers steam across the globe. This should continue to relieve pressure on conservative portfolios, which have faced serious headwinds over the past nine months as interest rates took off. Remember, bond and other fixed income prices usually fall when rates rise. This relationship is amplified when rates rise rapidly, which has certainly been the case.
May is ending on a relatively positive note as most April gains remain intact despite some intra-month volatility. First quarter earnings were positive and projected annual earnings growth is now approaching double digits. Those factors and some moderation in interest rates is a recipe for higher stock prices. I also expect the trend in rotation from technology to cyclical sectors to continue. Investors are always looking for value and assets like transportation, industrials, financials, and energy may continue to outperform as the world returns to normalcy.
Lastly, I would like to comment on the cryptocurrency sector. We have received questions about how to invest in that space and whether or not an investor should invest at all. The reality is that today these investments are primarily just trades. This means that an investor is betting that someone will pay more later for the crypto than the investor did today. In my opinion, this is akin to gambling. You might get rich, or you might go bust. This of course is why the price of these investments rises and falls by 30-40% with regularity. It is also why the SEC in the United States is having a hard time approving an ETF of these investments, and why guys like Warren Buffet and Charlie Munger are not fans. On the other hand, digital currency is quickly gaining a foothold as a method of payment in legitimate transactions. Young people who grew up with payment apps, debit cards, and other non-traditional methods of payment are now using Bitcoin and other cryptocurrencies… and they are excited about it. I don’t think it is going away and I think over time it will become part of a diversified portfolio – not as a trade, but as an asset. I believe it is at that point that the door to this investment will open for good.