Inflation, Taxes, Seasonality – Take Your Pick

So far, those of you who followed the market adage “Sell in May and Go Away” are enjoying that decision. The graph below shows the performance of four major market indices over the month of May so far. Spoiler alert, all are lower:

Normalized Month-to-Date Performance for Various Major Indices: S&P 500 (white), NASDAQ 100 (blue), Dow Jones (red), Russell 2000 (purple)

Source: Bloomberg

To be fair, the degree to which the “sell in May” strategy has been effective varies among the benchmark of your choice. The tech-heavy Nasdaq 100 (NDX) and small-cap focused Russell 2000 (RTY) have been lower all month and are performing worst. The more industrial-focused Dow Jones (INDU) and S&P 500 (SPX) performed well last week, only to pull back in recent sessions. Before today’s CPI-induced sell-off, INDU was actually up for the month and SPX was only down marginally. 

Inflation fears have gotten most of the blame for the recent dips in the broader market and credit for the rotation that have boosted stocks and sectors that benefit from higher prices in raw materials. We had been addressing investors’ inflation fears over the past week, (this piece discusses the topic and links to prior discussions) prior to this morning’s stunning inflation report. We saw headline CPI rise 0.8% vs an expectation of 0.2%, with the core rate rising 0.9% vs 0.3% expected. This put the year-over-year rise in CPI at 4.2%, well above the Federal Reserve’s 2% target. 

The immediate reaction from my wife summed it up well “This is a surprise? Has anyone been to a store recently?”But the immediate reaction from equity and bond futures showed that it was indeed a surprise. Both fell sharply when the numbers were released, and they have continued to fall throughout the session (by the time of this writing). Inflationary fears in richly valued markets can create a nasty feedback cycle. Higher inflation expectations boost bond yields (lowering bond prices), which tend to hurt stock prices because they lower the discounted future cash flows of companies, particularly those with premium valuations. 

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