An interesting development in 2021 has been the relationship between inflation expectations and market returns. With inflation expected to rise (this is reflected both in surveys of analysts and through a market-based calculation of forward derivatives on U.S. Treasuries), markets have sold off assets that tend to underperform when inflation rises–namely, low-risk bonds and, most of all, U.S. Treasuries.
That’s where the predictable response ends. Gold is down YTD despite gold typically rising with inflation expectations; the metal is flat over the past year following a short burst at the mid-point of 2020, before inflation expectations rose. This disconnect is unusual, and some have argued is a sign that gold’s relationship to inflation expectations is breaking down.
Other market responses are even more bizarre and hard to explain. Tech stocks, as reflected by the Nasdaq 100 (QQQ), have seen 3% daily drops in recent days and only very recently have come back from red territory for 2021. While tech’s relationship to inflation is nowhere near as straightforward as gold, the traditional belief in markets has been that risk-on assets (i.e., common stocks and growth stocks) will benefit from inflation, as higher prices mean revenue growth that should cause the valuation metrics of these assets to become more attractive.
Instead, tech stocks and U.S. Treasuries have been closely correlated in 2021, an oddity that is rarely seen in markets. Usually, one goes down as the other rises due to fund flows going from one to the other; when the market is fearful, Treasuries rise and tech stocks fall; vice versa when markets are greedy. But now the metric seems to indicate the market is both at the same time.
That may be an accurate description of reality. On the one hand, there is tremendous concern about macroeconomic fundamentals due to supply chain disruptions, disappointing vaccine rollouts outside of the U.S., higher energy prices resulting in higher PPI, and possibly challenged sovereign borrowing power due to the massive amount of stimulus payouts from the pandemic. On the other hand, there are signs of extremely bubbly activity, such as multi-million dollar NFT sales, a quadrupling of Bitcoin’s price in months, and the fact that tech is up 88% from a year ago.
Perhaps what we are seeing in tech is not an inflation-driven selloff but a selloff of worried investors seeing bubbly activity elsewhere, while other investors defy such fears by buying the dip. If tech’s selloff were a reflection of this market-based debate rather than inflation, we would expect more volatility in tech over the next few months, regardless of what inflation does. On the other hand, if we see inflation expectations continue to rise sharply as they have over recent months and tech stocks sell off, we can confidently say that there’s a new correlation between tech and inflation where there used to not be one.