June Market Recap: Inflation Is Here. Now What?

Optimism stemming from economic reopening propelled continued ascent in U.S. stocks, which gained for a fifth consecutive month and a fifth consecutive quarter. Accommodative monetary policy and government stimulus remain strong tailwinds for equities. International issues failed to keep pace in June, partly due to less effective vaccine rollouts.

Markets Unfazed by Inflation

In mid-June, following the highest annual increase in consumer prices since 2008, the Fed acknowledged inflationary pressures may force it to taper bond purchase or raise interest rates sooner than expected. While a more hawkish Fed is feared by many investors, markets were unfazed. Some may have found confidence the Fed will find the right balance between supporting growth and keeping inflation in check. Long-term interest rates declined, and the “reflation” trade in place for most of the past few quarters retreated. Growth stocks outperformed for the month, led by mega-cap technology.

From our perspective, higher inflation is already here. This does not mean we are headed to the stagflation of the 70s or double-digit interest rates from the early 80s. The pandemic created unique supply-and-demand shocks, which should normalize over time. The greatest headwind for inflation is innovation, which is in strong supply.

Still, with more massive stimulus packages likely on the way, investors may be underappreciating the odds the Fed will be forced to play catch up more aggressively. It would not be surprising to see the reflation trade and value stocks reassert themselves in the second half, especially as shutdowns ease across the globe and more people return to offices.