Market Watch: Why stubborn inflation has investors on the back foot

After a roaring start to the year, with investors optimistic that inflation was under control, share markets have slumped in recent weeks.

Wall Street’s Dow Jones Index is now down for the year to date and gains for the S&P500 and Nasdaq have slipped to around 3 per cent and 9 per cent respectively.

The NZX50 is up about 3 per cent for the year - although at one point it had surged more than 5 per cent.

So what has happened and how long until that optimism returns?

Strong US employment data, higher-than-expected core inflation figures and some tough talk on interest rates by the US Federal Reserve have brought markets back down to earth with a thump, says Pie Funds chief investment officer Mike Taylor.

“Markets got off to a great start for 2023. Part of that was because they were positioned so bearishly to start the year,” he said.

Then investors got a bit carried away by early signs of cooling inflation.

As we started the year there were expectations of rate cuts later this year being priced into markets, Taylor said.

Those cuts have now been pushed out to early 2024.

Since February we had heard the US Fed and New Zealand Reserve Bank come out and say inflation was still a problem and interest rates still have some way to rise, he said.

The Fed had been ”hawkish” since the figure for PCE inflation (an index of core consumer inflation) came in ahead of expectations, Taylor said.

The expected terminal (or peak) rate had risen to around 5.5 per cent.

Downturn threatens to spark renewed sell-off in Wall Street stocks and 'panic' in credit markets. Photo / AP

It showed that ”we are just not seeing that softening in prices that we had hoped. I guess it’s because the consumer is still quite resilient.”

“What you’d typically expect to see at this point of the cycle is the economy starting to slow, particularly with the amount of rate rises that we’ve had to go through,” Taylor said.

“So the fact that the consumer is still holding in there is probably a reflection of the fact that the unemployment rate is so low and people are still getting wage increases.

“If you’re a consumer and you’ve still got your job, you’ve had a pay rise, there’s probably no reason for you to stop spending, particularly consumers that don’t have any debt or haven’t got a mortgage.”

What all that meant for markets was that assets with longer-term profit outlooks - like tech stocks - had fallen out of favour and that was reflected in the Nasdaq’s pullback.

There had also been price falls for energy stocks and that had impacted the Dow Jones index.

That left us still waiting for some sort of economic landing - whether that might be hard or soft or any other variety, Taylor said.

“I think we’re just gonna be the sort of cork in the bathtub this year, getting washed around from side to side, where different theses start to play out, and it’ll all be very data dependent.

“So the market will be volatile around Fed speak and around inflation prints because those are the two important ones to drive markets this year.”

- The Market Watch video show is produced in partnership with Pie Funds.