Make the Most of This Historic Market

Stocks have been all over the place in recent days, but the overall direction has been to the downside.

Stocks sold off in a major way in recent days, after reaching record levels at the start of the New Year. Driving this rapid shift in sentiment is the fear of tighter Fed policy in response to inflationary pressures. The indiscriminate sell-off appears to reflect the market’s anxieties about the speed and magnitude of Fed interest rate hikes this year.

Many in the market interpreted the Fed Chairman’s words at the latest post-FOMC meeting press conference as very hawkish and indicative of tougher times ahead. Valuation worries also figure prominently in the bearish view of the market.

There are others in the market with more optimism about the outlook who see the recent sell off as providing an opportunity to buy quality stocks at discounts. This narrative is sanguine about the Fed, sees ongoing inflationary pressures as mostly Covid centric and sees nothing wrong with valuation given favorable outlook for interest rates and earnings.

The interplay of these competing views will determine how the market performs in the coming months and quarters. To that end, let’s examine the landscape of bullish and bearish arguments to help you make up your own mind.

Let's talk about the Bull case first.

Inflation & the Fed: The outlook for inflation and what that means for Fed policy is the biggest point of difference between market bulls and bears at this point in time. The bulls see the ongoing inflationary run as a direct result of Covid-related factors that will ease once the pathogen becomes endemic.

It is hard to argue with the bulls’ view that the pent-up demand in a number of product and service categories will eventually normalize, which will have beneficial effect on prices. Related to the above argument are expected favorable developments on the supply side of the equation as the pace of infections ease.

The Fed has stepped back from its earlier ‘transitory’ explanation of inflationary pressures and adopted a more hawkish posture. But bulls see that change as likely nothing more than securing greater flexibility for the central bank. In effect, the Fed purchased an insurance policy with this language change that allows it greater room to maneuver as the inflation picture evolves.

The Fed’s hard-won credibility on the inflation question is one of the biggest tools in its arsenal as it leads the market in the current environment of evolving inflation expectations.

Continued . . .

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Zacks Investment Research

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Written By: Zacks Investment Research