After being a thorn in the side of the market for more than three years, inflation is once again in the Federal Reserve’s 2% target range, falling to 2.9% in July (as reported in August) and then dipping further the next month, to a much more palatable 2.5%.
And with the comments in the latest FOMC meeting aimed squarely at the employment picture, it seems that inflation may well and truly be behind us.
That’s not to say that inflation has been an albatross around the market’s neck. Indeed, the S&P 500 is up more than 35% since the first CPI print north of 3% was reported in mid-May of 2021.
On a per-year basis, that’s actually ahead of the average annual return in the large-cap index of 9.90% since its inception in 1928.
So….no harm, no foul? Sort of. We did have to endure a bear market when inflation was peaking in 2022. And when the dust settled on all the selling and a new bull market emerged in late 2022/early 2023, the divide between “haves” (Magnificent Seven/mega-cap tech/artificial intelligence stocks) and “have nots” (basically everything else) was more pronounced than at any other time in the market’s history.
Thus, it hasn’t always felt like a true bull market these last 23 months, and unless you loaded up on mega-cap tech and AI plays, odds are your portfolio’s return these last three-plus years has trailed the 35% return in the S&P.
Fresh Legs for the Bull Market
The good news is, the bull market isn’t over! Despite an admittedly fraught August in which the VIX spiked above 65 (!) for just the third time in its history, a 13% correction in the Nasdaq and 8.5% pullback in the S&P on the heels of a less-than-stellar U.S. jobs report, escalating tensions in the Middle East, and the dreaded Japanese “carry trade” and a fresh round of selling once the calendar flipped to September, the S&P 500 is now trading at all-time highs. It appears the worst is behind us, at least for now.
Does that mean the next leg of the rally will be more egalitarian than it has been for most of the last 23 months? We’ll see. There have been stretches – like in the spring of 2023, November and December of last year, and this July – during which participation in this bull market has been more widespread, with small caps, value stocks and many unloved sectors joining the party. But those stretches have been fleeting. That said, small caps have, of note, been at the forefront of the charge since the Fed commenced cutting rates.
What Stocks Did the Last Time Inflation Was Low
Hopefully, a low inflation rate will translate to better market breadth, as it did from 2012-2020, a nine-year stretch in which inflation never topped 3%. During that low-inflation stock market environment, the S&P Equal Weight Index (+179%) mostly kept pace with the S&P 500 (+193%), despite often heavy weightings from the likes of Apple (AAPL), Amazon (AMZN), Google (GOOG) and some of the other usual Big Tech suspects.
Hopefully, this new period of low inflation will produce similar across-the-board returns.
To take advantage of a potential coming boom in the many sectors that have been overlooked and undervalued over the past two and a half years, I have a portfolio full of growth-at-value-prices stocks in my Cabot Value Investor newsletter.
