Trading on the floor of the NYSE, January 24, 2022.
The market has been in denial of the “inflation jar” and may now face more bear markets and “wild” price action in the coming years, according to Bill Smead, chief investment officer at Smead Capital Management.
The US Federal Reserve struck a hawkish tone on Wednesday as it assessed how to tackle inflation, which is at its highest level in 40 years. The central bank indicated that a first rate hike could take place in March.
So far this year, the market has been bound by volatility as investors try to measure the pace and extent of monetary tightening.
As of Wednesday, this month has been the worst January ever for the technology-heavy Nasdaq 100, the worst since 2009 for the S&P 500 and the worst since 2016 for the Dow Jones Industrial Average.
Smead spoke to CNBC’s “Squawk Box Europe” on Thursday, arguing that the Fed’s inaction over the past year, based on its belief that rising inflation was “transient”, had led the market to complacency.
“The market has been in denial of what we call the ‘inflation jerk.’ dynamics, certainly in the United States, “he said. .
In particular, Smead noted that since the onset of the pandemic, a disproportionate amount of people between the ages of 30 and 45 in the United States had grown to desire to own houses and cars and live outside major coastal cities and commercial hubs. He argued that this paradigm shift would not be arrested by this “late attack” by the Fed.
“In other words, they’re letting this go on for too long, and the market is just coming to terms with it. They’re all in denial, and they’re just now coming to terms with the beginning of eliminating their denial,” he said.
Smead drew parallels between the current order of macroeconomic events and the early 1970s order of the Vietnam War, President Lyndon B. Johnson’s “Great Society” – a series of ambitious domestic programs aimed at eradicating poverty and inequality and improving the environment – and the Arab Oil embargo of 1973.
“We had the pandemic war, we had Biden’s Great Society, and then the Saudi spring cut the legs of the US oil industry by taking the price to zero in April 2020,” Smead said.
“And then you pile up this high number of people forming households right behind, and lack of houses and lack of cars, and that’s the classic definition: Too many people with too much money chasing too few goods.”
Although his firm is not trying to time the market in the short term, he suggested that elevated price-to-earnings ratios, the extremely high valuations of growth stocks and other forms of “financial euphoria” mean the market may be heading for a ” extremely difficult period. “
“As a company, we assume that this will be like the 1970s, which was an ugly bear market in 73/74, and then it culminated in another bear market in 81/82, and there were only certain ways to make money, and they were all pretty much tied to making money on inflation, “he said.
“In other words, turn what is the negative into the positive, and you can see that in oil prices, you can see that in the price of housing.”
Smead argued that as savings are channeled toward Main Street instead of Wall Street, and continue to exert upward pressure on consumer prices, it will be equities that benefit from inflation that take the lead.
“The problem is that there are so few of them walking around and they have been so overlooked by all this ESG feather dust that it becomes something wild,” he said.
“We could see some really wild price actions, for example, in the oil companies that are actually trying to make money on this.”
However, Smead’s bleak prospects are not shared by everyone. BNP Pariba’s chief economist Luigi Speranza said that although Fed chairman Jerome Powell’s hawkishness now has the French bank pricing up to six rate hikes this year, it was not yet enough to derail their bullish outlook for US equities if earnings growth remains strong .