Earlier this week when US CPI data came in for August, it was a red-letter day for the US stocks. The US stock market went turtle with the three leading indices recording big losses on Tuesday. Nearly 1,300 points were wiped out by the Dow Jones Industrial Average index.
The US inflation numbers for August had increased 8.3% as compared to August 2021. Even though that figure actually shows a little decline from July’s 8.5% year-over-year figure, economists and investors had hoped for a quicker decline in inflation. The steepest one-day market sell-off in more than two years was sparked by disappointment.
“Unfortunately, the recent drop in gas prices was offset by higher prices in areas such as shelter and food,” says Chris Hyzy, Chief Investment Officer, Merrill and Bank of America Private Bank. Core inflation, which does not include gas and food, also rose more than expected. As a result, markets expect the Federal Reserve (the Fed) to raise interest rates by at least another .75% when it meets next week, he adds.
Wall Street investors know that a high-interest rate scenario will dent corporate profits and impact the company’s margins. In addition, the measures taken by US Fed, to bring down inflation to under 2%, could damage the economic conditions further. A full-blown US recession may have serious repercussions for the market as well.
“Inflation may have peaked over the summer, but it remains well above the Fed’s target of 2%,” Hyzy says. “Therefore, we expect to see continued choppy markets over the near term.” Tuesday’s drop, ending an extended rally through much of July and August, should be seen in the context of a post-pandemic “reset period” of uncertainty and mixed signals, he adds. “We expect the reset to last six to nine months, after which we should see a return to more normal market valuations.”
Given the likelihood of volatility for months to come, investors may want to consider defensive steps for their portfolios, Hyzy suggests. Depending on your situation, that may mean adding so-called defensive stocks, such as utilities and healthcare, which tend to offer stability and consistent returns even when the economy and markets struggle. For more conservative investors, that could mean reducing your exposure to equities. Still, long-term investors may find strategic opportunities to buy equities that could perform well as the economy and markets stabilize. “We continue to suggest maximizing diversification across asset classes and positioning yourself for the long term,” he says.