Rotation As A Motivation In The Face Of Inflation

Market action so far today is a matter of perspective. If you’re old school, watching the Dow Jones Industrial Average (INDU), today is a solid day, with that measure rising by over 3/4%. Not bad. As I write this, the S&P 500 Index (SPX) is back to trading roughly flat after a brief flirtation with minor declines. Yet the NASDAQ 100 Index (NDX) is over 1.5% lower, giving back all its Friday gains and then some. What gives?

The short answers are rotation and inflation. Tech stocks are out of favor today as investors digest the potential for inflationary ramifications arising from Friday’s payrolls report. We can debate whether inflation is itself a drag on tech shares, but we would certainly assert that the valuation of the highest-flying tech stocks is dependent upon monetary accommodation and low-interest rates. The lower the prevailing interest rate, the higher the present value of future income streams and cash flows. When we consider that the most popular tech stocks trade at historically high valuation measures, anything that threatens those valuations becomes a negative. Higher inflationary expectations and/or a pause by the Fed are viewed as potential threats by tech investors. Because the vast majority of NDX’s weight is in tech stocks, a broad tech selloff is by necessity a drag on NDX.

Inflation has been a recurring theme in this space for several days. On Wednesday and Thursday, we explained how the mechanics of the commodity futures market could explain the Federal Reserve’s view that current inflationary pressures are transitory. Many of the sharpest rises in traded commodities have pushed their futures markets into backwardation, a situation that implies that short-term supply shortages are likely to ease over time. We also noted that the Fed seemed to be overlooking that even in backwardation, the futures markets are often anticipating significantly higher commodity prices over last year. Our conclusion ahead of the payrolls report was that the Fed would be comfortable with the consensus outlook for about 1 million new jobs and no increase in hourly wages, while a “significant deviation in either of those statistics (or the others that will be reported) could surprise investors and change the tone of the inflationary debate.” 

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Disclosure: FUTURES TRADING

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