Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen made their first joint appearance before Congress yesterday, delivering remarks to the House Committee on Financial Services.

Questioned yet again about inflation, Powell said: “We’ve been living in a world of strong disinflationary pressures for the past quarter-century. We don’t think a one-time surge in spending leading to temporary price increases would disrupt that.”

Nonetheless, expectations for high inflation abound.

This is not necessarily bad for stock investors, particularly small-cap-stock investors. According to CME Group, small caps have been the best place for stock investors during periods of rising inflation expectations:

“Since 2010, small-cap stocks have outperformed large caps during periods of rising inflation expectations and vice versa. 2020 was no exception.”

This happened some 40 years ago as well:

“January 1979 – July 1983: The Russell 2000 outperformed the S&P 500 by 77%. During this time, inflation rose to as high as 13% and the economy suffered a double-dip recession in 1980 and 1981-82 before staging an extremely strong recovery in 1983 with growth rates as high as 8.5%.”

Whether the current outperformance by small caps is due to rising inflation expectations is unclear. CME Group wrote in January:

“While they have risen substantially from their lows in March, inflation expectations at 2.1% over the next 10 years are not especially high by historical standards. That said, a tight labor market might be a prerequisite for durably higher inflation. Now, with the labor market still significantly disrupted by the pandemic, a demand for higher wages in the US or elsewhere would seem unlikely. However, large budget deficits and continued central bank quantitative easing could help to elevate inflation down the road.”

Whether because of inflation expectations, reopening hopes, or something else, small caps have dominated the post-vaccine market. Chart of the Day makes it plain:

(Click on image to enlarge)