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When It’s Time to Change

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Investors are shifting gears in the wake of good inflation news. Will it last?

The tide is turning—maybe.

Following last week’s news of lower-than-expected inflation, investors staged a massive rotation out of market sectors with strong recent performance and into sectors suffering in the high inflation/higher interest rate environment.

This sentiment shift was displayed in the Dow Jones U.S. Thematic Market Neutral Momentum Index—a benchmark consisting of long positions in positive-momentum stocks (strong recent performers) and short positions in negative-momentum stocks (recent weak performers). The index plummeted 9.1% over Thursday and Friday, as seen in the chart.

We view this price change as an indication investors were encouraged by the latest data and believe it will prompt the Fed to slow its inflation-fighting efforts. They decided to sell recent winners (healthcare, utilities, energy, and consumer staples) and scoop up the laggards (such as technology and communication services). A closer look reveals that the recent underperformers drove most of the index’s big move—with the negative-momentum “short side” of the index rallying 14% in just two days.

The obvious question: Are investors right? Was last week the turning point that will lead to continued lower inflation, a more dovish Fed, and a new trend in market leadership?

At Horizon, we’re encouraged but not yet convinced that those outcomes are locked in based on one month’s inflation data. For some perspective:

  • The last time we saw such a momentous shift in market winners and losers was in November 2020—right after Pfizer announced its coronavirus vaccine was found to be more than 90% effective in preventing Covid-19. Back then, investors sold the “stay-at-home” stocks that had been soaring and bought sectors that would benefit from economies opening back up.

  •  This latest 14% two-day move in the short side of the index is more extreme than the short side’s reaction to the Covid vaccine back then.

 

The upshot: Investors appear to be reacting more strongly to one surprisingly good inflation report than they did to the announcement of the coronavirus vaccine—a situation that we think demands some caution.

As we opined in our 3rd Quarter Report, “one month of positive news on inflation will not be adequate.” Instead, we believe the Fed will want to see at least three months in which the month-over-month inflation rate (adjusted on an annualized basis) comes in at around the Fed’s long-term target of 2%.”

Going forward, we’ll be looking for more evidence that the Fed can feel confident easing off the gas. For now, as the data shows, we may be moving in the right direction.

 



This commentary is written by Horizon Investments’ asset management team. 

Past performance is not indicative of future results.

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