Investing

Breaking Even

I’m reluctant to write about something so mainstream as inflation but I can’t help but notice a few unavoidable important data points.

First, 5-year and 10-year inflation expectations have stopped going up and are actually modestly retreating. The peak in inflation expectations occurred a few days after the release of April’s “monster” CPI figure, which apparently confirmed the rampant inflation so many have been anticipating. Forget that the year-over-year comp was at the depths of the pandemic-driven recession. The funny thing is the CPI print almost appears to have been a sell the news event versus a trend confirmation.

5-year Breakeven Inflation Rate

10-year Breakeven Inflation Rate

Another interesting observation is the decline in the 10-year US Treasury rate, which took another leg down right around the time breakeven rates started to fall. Treasury rates had already began to cool off prior to this time leaving one to wonder if the bond market is pricing in a slow down in growth.

Not surprisingly, growth stocks began to outperform value stocks not too long after the rise in breakeven rates stalled.

The bond market is typically assumed to lead the stock market. In this instance, Treasury rates stopped going up first (and then declining modestly), then breakeven rates stopped going up and started to decline and then the reflation trade reversed course.

Declines in treasury rates usually indicate an expected slowdown in growth. Declines in breakeven inflation rates obviously indicate an expectation for inflation to be lower, most likely as a result of lower growth expectations. Growth stock outperformance in recent years has generally been the result of lower growth expectations in the economy, leading investors to bid up companies with higher growth profiles. It would appear the same playbook from the last several years is being used by investors once again. This all could be the result of the reflation trade taking a breather before continuing its march higher, or it could be the end of the reflation trade. I don’t which it is, which is why the portfolios I manage have exposure to both growth and value.

In parting, we won’t really know if inflation is taking hold until later this year. If the inflation trend does end up moving higher, I have to wonder if it will be the result of accelerating growth or dollar debasement or perhaps a combination of the two.