Inflation Is Testing the Stock Market's Resolve

The stock market moved generally higher on Thursday, with the S&P 500 (^GSPC -0.15%) climbing to a new all-time high. The Dow Jones Industrial Average (^DJI 0.49%) and Nasdaq Composite (^IXIC -0.77%) also moved higher, although they both still have a bit further to climb before claiming records of their own.

Data source: Yahoo! Finance.

Ordinarily, one might have thought that troubling inflation news that came out on Thursday morning would have been enough to cause some to question whether the bull market would be able to continue. However, not only did stocks not react strongly to higher prices, but the bond market also seemed surprisingly unconcerned by the news.

Image source: Getty Images.

What the latest inflation report said

Inflation as measured by the Consumer Price Index rose by 0.6% during the month of May. That brought the total year-over-year rise in prices to 5%, which is the fastest rate of inflation since 2008.

Often, past inflationary spikes have accompanied big rises in energy prices. Yet that hasn't been the case this time around. Even when you remove the volatile food and energy categories, so-called core inflation rose 0.7% for the month and has gone up by 3.8% since May 2020.

Some of the culprits were the same as they were last month. Used car and truck prices spiked 7.3% higher after a 10% jump in April, bringing their year-over-year gains to nearly 30%. Similarly, rental car prices soared 12.1% for the month, and airfares were higher by 7%.

No ado about something?

Interestingly, the financial markets gave a collective yawn to the numbers. Last month, when the first round of heavy inflation came, stocks fell sharply on worries that the Federal Reserve would have to raise interest rates in order to rein in price increases.

However, this time around, it seems that investors are more confident that the Fed will remain lax in its monetary policy even with these pressures. Even though the argument is weaker after a second straight month of huge rises, market participants are clinging to the hope that these increases will reverse themselves once economic conditions return to something resembling the pre-pandemic normal.

As a result, the 10-year Treasury yield moved below 1.5% and hit its lowest level since early March. Rate sensitive stocks reacted in kind, with financial companies like JPMorgan Chase (JPM 0.84%) and Goldman Sachs (GS 0.74%) seeing declines of roughly 2%. With interest rates remaining low across the yield spectrum, the opportunity for big banks to profit from rate spreads simply doesn't seem to be growing despite the inflationary news.

Wait 'til next month

It takes time for economic trends to assert themselves, so even two straight months of concerning numbers shouldn't cause a panic. Nevertheless, if prices stay at elevated levels for long, it'll force investors to consider the possibility that something truly is different this time.