Will Dow Jones Outperform Nasdaq 100 as Inflation Debates Heat Up?

DOW JONES FUNDAMENTALFORECAST: BULLISH

  • Dow Jones gained 11.4% while the Nasdaq 100 fell 0.2% since early February
  • Rising commodity prices sent the 5-year breakeven inflation rate to a 13-year high
  • Reflation hopes may continue to buoy Dow Jones as the US and Europe prepare to ease lockdowns

The reflation theme appears to have returned to center stage, encouraging investors to rotate away from pandemic winners and into cyclical sectors such as energy, materials and financials. Investors applauded reopening optimism as parts of the Unites States and Europe prepare to ease Covid-related lockdown measures. Meanwhile, the 5-year breakeven inflation rate hit a 13-year high as commodity prices continued to rise, underscoring supply shortages and pent-up demand.

The US aims to have 70% of adults vaccinated before July 4th. A positive vaccine outlook may dent demand for digital products and services, enticing profit-taking in some of the world’s largest technology companies such as Apple, Amazon and Netflix. The upcoming summer driving season may further boost physical demand for fuel, hotels, cars and entertainment.Against this backdrop, the Dow Jones Industrial Average may continue to outperform the tech-heavy Nasdaq 100 as the economy moves towards normalization.

The Dow Jones Industrial Average rallied 11.4% since early February while the Nasdaq 100 index fell 0.2% during the same period (chart below). This makes perfect sense in the context of a return-to-normal earnings boost for brick-and-mortal businesses at the expense of digital services.

Dow Jones vs. Nasdaq 100 – February to May 2021

Chart created with TradingView

Reflation hopes and robust demand sent commodity prices to their highest level since 2011, according to an index compiled by Bloomberg. The gauge comprises a wide range of energy, metal and agricultural products. The 5-year breakeven rate, a proxy of bond traders’ inflation expectations, surged to 2.7% – a level not seen since 2008 (chart below).

Rising inflation expectations and robust economic data have seeded divergence among Fed officials. Some of them suggested it is time to debate tapering stimulus while a majority supported the view that upward price pressure might be transitory. The knee-jerk reaction last week following Treasury Secretary Janet Yellen’s interest rate comments reflected the fragility of risk assets amid tapering fears. Polarised views on the Fed’s future monetary policy guidance may lead to higher volatility in the stock market, especially the rate-sensitive technology sector.

Commodity Prices vs. 5-Year Breakeven Inflation

Will Dow Jones Outperform Nasdaq 100 as Inflation Debates Heat Up?

Source: Bloomberg, DailyFX

— Written by Margaret Yang, Strategist for DailyFX.com

To contact Margaret, use the Comments section below or @margaretyjy on Twitter

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