Market Review - May 2021

June 7, 2021

By Jan Faure

Inflation the focus for markets during May.

Global markets were once again shaken by inflation concerns in May. In the US, April inflation data released mid-month showed the highest consumer price index (CPI) increase in 12 years. The reading (+4.2% y-o-y) was well ahead of market consensus (+3.6% y-o-y) and immediately dragged markets lower. That was followed by data showing producer prices (PPI) jumped by 6.2% in April, the biggest increase since 2010. The advance in PPI has been driven by a rally in most commodity prices including as copper, iron ore and lumber, which are sitting at record or multi-year highs.

Dow Jones Commodity Index (Energy, Agriculture and Livestock, andMetals)

Markets are sensitive to an inflation rise and fear it will force the world’s central bankers to increase interest rates and in so doing jeopardise the post-Covid economic recovery. The US Federal Reserve has insisted that it expects the price spike to be transitory due to last year’s low base. The Fed’s stance is that it won’t make any adjustments to monetary policy until unemployment numbers improve and inflation has run above target for some time. Markets are concerned that inflation data does not cool down over the next few months raising pressure on central banks to act.

The inflation debate is the leading driver of investor behaviour in markets at present. It is affecting both asset allocation and decisions around the types of securities that can best withstand the prospect of tighter monetary policy. Markets do not appear ready for a shift to tighter policy and are hence highly sensitive to any indications of it.

US Consumer Price Index Y-o-Y change %

Low interest rates coupled with trillions of dollars in stimulus have fuelled a major rally in world equities since the pandemic induced collapse in February last year. Equity markets are not cheap by historical measures, especially technology stocks. Higher interest rates make elevated equity valuations harder to justify. This explains why the tech-focussed NASDAQ index underperformed other major market indices in May following higher than expected inflation data. Many tech company valuations are based on distant future earnings discounted to present value at (potentially unsustainably) low interest rates.

The argument that inflation pressures are transitory is compelling. There are a few key shifts in the world today that are working against inflation forces. These include technology (innovation) and changing demographics. Technology disrupts the status quo by making things and services either more efficient or cheaper, usually both. There are countless examples of this but think about the sharing economy (UBER reducing the need to buy a car), and how faster internet is driving competition up (and prices down) in all forms of digital content.

The other force is demographics. Populations in many parts of the world are aging including the US, Europe, China and Japan. Families are getting smaller while advancements in healthcare are leading to increases in life expectancy. Older generations slow their spending which is highly deflationary. Japan is a prime example of a country that has been stuck in a deflationary trap since the 1990’s.

Central banks are taking the view that this year’s inflation spike is led by a combination of pent up consumer demand and supply chain shocks (and bottle necks) due to the Covid pandemic, and believe this to be temporary. The direction of inflation data for the remainder of the year will be closely watched as it will most certainly have a bearing on investor returns this year.

GLOBAL INDICATORS: Local reporting currencies

Source: Bloomberg,, S&P Dow JonesIndices
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