02.04.2022: The prospect of high and sustained inflation is one of the biggest risks facing investors this year.  Today’s jobs report highlighted that risk.  Persistent inflation, like a house fire, would force the Fed to barrel in and hose down inflation without regard for the upholstery, in this case equities.

Defying economists and omicron, employers added 467,000 net new jobs in January.  Economists were calling for about 125,000 net new jobs last month.  Meanwhile, the Labor Department’s report also showed average hourly earnings rose 5.7% from a year ago and 0.7% month over month, fanning inflation’s flames.  The report underscores the strength of the job market and places the Fed behind the curve.  Treasury yields jumped in response.  The 10-year Treasury yield surged 0.10% to 1.92%, its highest level since 2019.  Now, Fed funds futures markets imply five quarter-point rate hikes this year, up from three rate hikes a month ago.

Graph 1, Market Update, 02.04.22

Higher interest rates, particularly 10-year yields, could weigh on stock prices.  At 20 times forward earnings, the S&P 500 is currently trading at a 5% forward earnings yield.  A 0.5% increase in the forward earnings yield to 5.5% would imply a forward price-earnings ratio of 18 times, which is about 10% below current prices, all other things equal.

Graph 2, Market Update, 02.24.22

We expect growth and inflation to peak in Q1 2022 and trend toward pre-pandemic rates by the end of the year.  In the meantime, investors need to prepare to digest daunting data.  Next week’s CPI report will likely be no different.  We will continue to update our forecast as new data becomes available.  If our current forecast plays out, we expect near term downturns to offer longer term opportunities.