June 11 (Bloomberg) -- Inflation has taken hold in the stock market as the prospects for earnings and the economy are worsening, according to Barry C. Knapp, Barclays Plc’s head of U.S. equity strategy.
The CHART OF THE DAY shows how Knapp drew his conclusion, presented in a June 7 report. He compared the Standard & Poor’s 500 Index’s forward price-earnings ratio, based on anticipated profits, with the Institute for Supply Management’s new-order index for manufacturers.
During May, the forward P/E climbed to a three-year high of 15.2, according to data compiled by Bloomberg. Yet the ISM gauge fell last month to 48.8, its lowest level since July. Readings below 50 signal a contraction in new orders.
The contrast shows how much stocks have been affected by the Federal Reserve’s bond purchases, Knapp wrote. He described the central bank’s policy of quantitative easing as “QE4ever,” referring to the three rounds of buying authorized so far and the potential for more.
“We can’t help but conclude that QE4ever has contributed to asset inflation,” Knapp wrote. “In our view, this was the Fed’s intent.” The New York-based strategist expects the S&P 500 to end the year at 1,525, a decline of 7.2 percent from yesterday’s close.
Stocks may do little to safeguard investors from the risk of accelerating inflation in the economy, he added. He cited a historical analysis that showed equities were “a poor hedge,” especially when consumer prices were surging or in periods of stagflation, when the economy was contracting.
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