Inflation and bear market considerations for investors

Anthony Saglimbene, Global Market Strategist – Ameriprise Financial

As of June 20, 2022

We have entered a good news is bad news type of market environment, in our view.

Investor anxiety is high. Inflation is at record levels. And there are fears the Federal Reserve could raise interest rates too aggressively.

In such an atmosphere, incoming economic releases that come in stronger than expected, particularly on items of employment and inflation, are likely to be greeted with an adverse investor reaction, as they signal the Fed may need to keep pushing interest rates higher.

Inflation and bear market considerations for investors

As investors consider the potential impacts of entering a bear market, they naturally have questions about what this means for their portfolio and their ability to reach their financial goals. Ameriprise Financial experts discuss the impact of inflation and rising rates, opportunities for investors and goal-specific investing strategies.


The outlook on unemployment and inflation

The May jobs report is a perfect example of the good news is bad news dynamic. May jobs rose +390K while the unemployment rate held steady at 3.6% for the third consecutive month. However, job growth last month was more robust than the +323K expected. As such, investors viewed the report as confirmation the Fed would be undeterred in its efforts to raise interest rates to stamp out inflation.

And sometimes, bad news is just bad news. The May consumer price inflation (CPI) report is a glaring example that elevated prices for just about everything are an ongoing problem for the economy and markets — and that the Fed still has a lot of wood to chop to get monetary policy in line with inflation. Headline consumer price inflation rose +8.6% year-over-year last month, surpassing March's highwater mark for the current cycle and hitting the highest level since December 1981. Core inflation (excluding food and energy) rose +6.0 y/y in May and was down slightly from April's +6.2% level. However, both measures in May were hotter than expected and quickly put to rest the idea that peak inflation is in the rearview mirror.

Even so, it’s not all doom and gloom out there. 

Here are seven bullish points for investors to consider through what could still be a challenging second half of the year for stocks:

  1. The demand environment remains strong. The economy is likely to grow this year, consumers are on solid footing, the job market is tight and a lot of pain has already occurred in the stock market.
  2. Fundamentals remain solid, but trends are shifting. Economic activity is slowing, inflation is high and consumer trends are changing. At the same time, corporate profits/margins are downshifting from extraordinary levels. In such an environment, recession talk can naturally get more attention, and asset prices are increasingly pricing in a growing possibility of a shallow recession. However, without a more material downshift in consumer behaviors and a sea change in the labor market (which remains strong), it’s still a stretch to assume the economy is predestined for a recession over the near term, in our view.
  3. More attractive entry points for stocks may be beginning to emerge. The S&P 500 Index’s last 12 months (LTM) and next 12 months (NTM) price-to-earnings ratios have fallen considerably. For example, the S&P 500's LTM P/E ratio has fallen over 40% since April 2021, while the Index's NTM P/E has declined by over 30% since July 2020. The combination of slowing profit growth and less willingness from investors to pay up for those profits in a highly uncertain environment has helped reset P/E ratios for the S&P 500 and a host of its constituents this year. While stock valuations could continue to reset lower, more attractive longer-term entry points are beginning to emerge, in our view.
  4. Markets will likely look for signals the Fed is preparing to slow rate hikes. Stock volatility could come down when the Federal Reserve and other central banks begin to signal that they have hiked rates and/or removed enough monetary accommodation to tame inflation. While we are likely a ways off from a less hawkish Fed, the market will look to anticipate the shift ahead of any such announcement, and we suspect stock prices could react positively.
  5. Lowering the earnings bar could provide more room for companies to outperform expectations. Over the coming weeks and months, we expect analysts to reduce earnings estimates, and an increasing number of companies to issue negative profit guidance for Q2 and make mention of higher costs eating into profit margins. Market bottoms are often formed once the deck chairs are reset and stocks stop reacting negatively to bad news.
  6. Home values remain stable. While higher interest rates are beginning to erode housing demand, inventory remains tight, and demand is moderating from unsustainably high levels. As a result, the housing market remains on solid ground, in our view. Moreover, home values are crucial in shaping how consumers feel and behave. Although consumer sentiment sits at its weakest levels in decades (due to high food and energy costs), still stable home values remain a counterbalance to the negativity.
  7. Three big inputs to global inflation are starting to ease from their peaks. Bloomberg recently noted that three big inputs to global inflation are starting to ease. DRAM contract pricing (i.e., semiconductors for a host of electronic products), the spot rate for shipping containers and fertilizer prices are all below their peak levels.

It’s all about inflation

We believe inflation is the most significant threat to the market/economy today. Along with higher prices, inflation influences two key market dynamics: interest rates and energy prices. We suspect stocks would likely grind lower if both rates and energy prices are headed higher. However, our view remains that core inflation may peak in the months ahead, but the evidence of the peak may not look linear. Although broader energy and food prices could remain elevated as the war in Ukraine and supply disruptions continue, higher prices for goods could moderate over the coming months. 

Bottom line: As food and energy prices have soared this year, there has been less discretionary money to spend in other areas, particularly for lower-wage earners. Over time, we believe changing consumer habits, easing supply chain pressures and higher rates will help bring down inflation. This is a good thing. However, investors' unanswered question is how disruptive the process will look to growth.

What can investors do?

Understandably, investors may feel uncertain about their investment portfolio against the backdrop of elevated stock and bond volatility, steep year-to-date losses and an economic environment that remains highly uncertain. Here are a few strategies for investors to keep in mind as we move into the second half of the year:

  • Maintain a properly diversified portfolio of stocks, bonds, cash and alternatives.
  • Explore strategies in the alternatives space to help mitigate equity risk.
  • Maintain discipline, utilize a systematic dollar-cost averaging approach and incorporate intelligent drawdown strategies for those in retirement.

If you have concerns or questions about these or other topics, contact your Ameriprise financial advisor. Together with your financial advisor, you can review current market conditions, portfolio allocations and investment solutions. Your financial advisor can help identify solutions and strategies that may help mitigate volatility and complement a well-diversified portfolio, and they can work with your tax professional to determine smart tax-loss harvesting strategies.

Data source for indices and sector graphs: Morningstar Direct, as of June 20, 2022. Past performance is not a guarantee of future results.