Inflation Sensations

Doug Walters, CFA

Inflation stole investor headlines again this week, dragging down stocks. With all the negative news investors have had to absorb, they may be surprised to step back and realize that US stocks have held their value over the past four months.

Contributed by Doug Walters, Max Berkovich, David Lemire,

Is anyone else out there tired of talking about inflation? It is exhausting! But it is driving investor behavior, so once again, we reluctantly dive into everyone’s least favorite topic, rising prices! This week we got a fresh look at pricing trends, and investors were not pleased. Tuesday’s worse-than-expected Consumer Price Index (CPI) set a negative tone that persisted throughout the week.

At first glance, inflation falling from an annual rate of 8.5% in July to 8.3% in August doesn’t sound that bad, even though it missed expectations for a decline to 8.1%. But this is the headline number. The “core” inflation print, excluding volatile food and energy prices, was of more interest. And there, we saw inflation increase from 5.9% to 6.3%. For investors, that felt like one step forward, two steps back.

One of the bigger culprits in the details was “shelter.” Despite rising interest rates, the cost of housing continues to drift up. We would expect the Fed’s rate increases to bite into the shelter line item eventually, but so far, consumers are defying that pressure.

So why did stocks have such an adverse reaction? It comes down to the Fed and what their response will be. Any setback in the fight against inflation means the Fed will have to be more aggressive in its rate increases. It also diminishes the probability of a soft landing. A “soft landing” is the Goldilocks scenario where the Fed gets inflation under control without doing too much damage to the economy. Stubborn inflation means that Goldilock’s porridge just got a few degrees colder.

So is it time for investors to start running scared? Of course not. Just as CPI was a drag this week, it could be a boon next month. It is a dangerous game to guess what is priced into the market, and an even more dangerous game to try and predict and take advantage of the next market gyration. A better bet is staying invested at your “right level of risk” for the long run.

Over the past few months, we have seen horrible headlines regarding the war in Ukraine, inflation, and the risk of a global recession. Yet, the US stock market performance has been flat over the past four months. There have been dramatic ups and downs along the way, but overall, the market has held up remarkably well. We do not know the next move the market will make, but we know that market volatility is normal. We also know that bad times come and go, and the most important thing an investor can do is ensure they are fully invested to enjoy the next bull market when it eventually comes – and it will.

6.3%

Inflation surprised to the upside in August… but

Tuesday’s inflation report disappointed on most fronts, with core inflation rising 6.3% from 5.9% in July. But some prices are coming down. Here are some areas for “glass half full” readers to focus on:

Gasoline may be up 25.6% year-on-year, but it was down 12.2% in August.Televisions are down 2.2% in August and a whopping 19.1% compared to last year. Time to upgrade!Computers and smartphones (IT commodities) fell slightly on the month and are down nearly 9% over the year.Automobile rental prices are down over 6% versus last year, as are admission prices to sporting events. So it is time for a road trip to go see your favorite football team!

Headline of the Week

US Stocks fell over 5% this week as the inflation print on Tuesday (CPI) disappointed investors. Adding to investor pessimism and winning the title of our “headline of the week” was a profit warning from FedEx (FDX).

FedEx has unique insight into world economic activity due to the global reach of its delivery business.
After hours on Thursday, the company issued a profit warning, noting a weakening global economy, particularly in Asia and Europe.
CEO Raj Subramaniam stated that the slowdown in their business is likely an early sign of a global recession.
Shares in FDX were down 22% on Friday.

For investors, the question is not just, “is a recession coming?” but, if so, how much of that news is already priced into shares? It will be a bumpy recovery ride, and we advise long-term investors to put their seatbelts on and keep their arms and legs inside the vehicle.

The Week Ahead

All eyes are on the banks next week. Central banks have rate decisions to make, with our Federal Reserve Bank being the biggest one.

50 no more

The Federal Reserve bank, only a week ago, was facing a 50-basis point rate hike or a 75-basis point rate hike decision. It is now probably looking at 1% as a possibility.

Stubborn inflation numbers are not backing down, leaving the central bank with no room to take it easy.
Fed Funds futures imply a 25% probability of a 1% hike on Wednesday.
Those same futures still see a rate cut in 2023 after the Federal Reserve moves rates to over 4% by year-end.
With only housing starts and existing home sales on the calendar before the meeting, it looks like all the data is already on the table.
After this meeting, the Fed will be on the sidelines until November, so going big may make sense.

Back to Business

With the passing of the Queen, the Bank of England had to move its rate meeting one week.

The funeral is on Monday, and a rate decision will be on Thursday.
The delay pushed the Bank of England to second fiddle as it would have been the marquee news item the previous week.
The decision to raise rates by half a percent or 75 basis points is still the big question.
On a side note, Kwasi Kwarteng, the new Chancellor of the Exchequer, and the New Prime Minister Liz Truss are about to make some policy changes, which include reversing corporate tax hikes.
With the European Union hiking by ¾ of a percent, would the hope of fiscal policy change be enough to keep the UK from matching that hike?

Yen on the line

Japan is not printing nearly double-digit inflation numbers like the rest of the developed world. However, it did climb year-over-year, 2.6% in July and 2.4% in June. That said, the urgency to hike is not based on inflation but on weakening currency.

The Yen at about ¥140 to a US Dollar is very weak, the weakest since 1990.
Japan reported a record trade deficit of ¥2.82 Trillion in August as the weak currency further inflates import costs for the energy-import-dependent nation.
With trading partners the US, the UK, and Europe all raising rates, how long can the Bank of Japan sit it out?

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