Strategists at Capital Economics think that inflation in the US will prove more persistent than both the Fed and investors appear to anticipate. Notwithstanding, they still expect the S&P 500 to make some further gains over the next couple of years.

Higher inflation not to derail US equities

“We still expect the US economy to grow strongly over the next two years thanks to a combination of loose fiscal and monetary policy, and for this to support corporate earnings and appetite for risk generally. Indeed, we think that, in light of its new framework, the Fed will keep the real stance of monetary policy loose over the next few years, even as inflation proves more entrenched.”

“A lot of good news on the economy already appears to be reflected in the current level of the S&P 500. However, we think there is still scope for earnings in some sectors that have been hit particularly hard by the pandemic to surprise to the upside.” 

“While we think that the rise in the 10-year TIPS yields will prevent the valuation of US equities from increasing further we doubt that it will cause it to plummet. After all, we still expect the yield of 10-year TIPS to stay very low by historical standards. What’s more, stock market valuations have often only tended to fall when profit margins have been squeezed by a faltering economy.”

“While our view that inflation in the US will prove persistent is a reason why we forecast gains in the S&P 500 over the next few years to be small, we are not anticipating a repeat of the sharp sell-offs seen during the periods of high inflation in the 1960s and 1970s.”