Inflation Overshadowed the Election and Crypto

Doug Walters, CFA

Good news on inflation overshadowed surprising election results and an implosion in the crypto space.

Contributed by Doug Walters, Max Berkovich, David Lemire,

If there ever was a need for more proof that the only thing that matters for investors right now is the Fed and inflation, this week provided it. We had an election that took a surprising turn, and the cryptocurrency market imploded, yet investors cared much more about a small improvement in inflation.

Elections always bring angst and this week’s midterms were no different. We spent the last two weeks reminding investors that political parties have historically had little influence on investment returns and that the economy is a much bigger factor. This week that dynamic was on full display. The results of the election were far different than expected (no red wave), and as we write, we still do not know which party will control The House and Senate. Yes, the stock market sold off a bit on election day, but that move was quickly overshadowed by inflation data.

On Thursday, CPI inflation came in a bit lower than expected, and investors rejoiced (perhaps a bit too much?). US stocks were up nearly 6% on the day. Why? Any surprise to the downside of inflation has the potential to influence the Fed’s decisions on interest rate increases. Prior to Thursday, the expectation was for another 75 bps increase in December. Now 50 bps seems more possible. Any reduction in the need to raise rates is a direct boost to equity valuations, particularly for growth stocks.

Also overshadowed by inflation was the implosion of the cryptocurrency market, which we discuss more below. No one should be surprised that a day of reckoning came for crypto.

So is this the beginning of the next equity bull market? It is way too soon to make that call. The Fed may choose not to slow its rate increases, or the next inflation print could be a negative surprise. Both of those scenarios would likely be a drag on equities. Disciplined, evidence-based investors know the best option is always to stay invested at a level of risk that is appropriate for you. Anyone sitting out of the market on Thursday was dealt a painful reminder that market timing doesn’t work.

-23%

Decline in Bitcoin this week

Bitcoin and other cryptocurrencies have been quietly imploding over the past year and not so quietly this week. The bellwether of cryptocurrencies fell about 23% this week and is down around 75% over the past year. The decline is not surprising, given that the primary utilities are speculative gambling and criminal activity. Driving sentiment this week was that FTX, one of the “premier” crypto exchanges headed by crypto-darling Sam Bankman-Fried, filed for bankruptcy after facing a liquidity crunch. One day FTX had a purported value of $32B. The next $0. Such is the risk when basing your business on a product whose value is speculative. Expect more drama to unfold as we learn more about what transpired in the preceding days between FTX and competitor Binance (who briefly offered a bailout before withdrawing).

Want to learn more about crypto and its risks? See our whitepaper from earlier this year (Cryptocurrency 101 – A Primer).

Headline of the Week

US large-cap stocks were up over 5% this week as investors weighed the impact of an election and inflation. The election results caught investors off guard, but inflation data stole the show and is our headline of the week.

CPI inflation fell more than expected on Thursday from 8.2% to 7.7%. The consensus was expecting 8.0%.
Core inflation (ex-food and energy) fell from 6.6% to 6.3%. The consensus was expecting 6.5%.
The decline was fairly broad-based, with shelter being a notable exception. The “Rent of Shelter” category continues to accelerate higher steadily.
The market reaction was swift. The S&P 500 rose 5.5% on the day, with beaten-down tech stocks enjoying a particularly good day.

The Week Ahead

After an exciting week to start the month, next week will be a step down. The focus will turn abroad unless some new election-related developments shake things up.

At Home

U.S. Producer Price Index (PPI), Retail Sales, and various housing reports are on the calendar for the week.

PPI is expected to increase by 0.5% month over month. If this inflation reading surprises to the lower side, like the consumer reading did, markets would love it.
The housing market has been responding to higher rates, and expectations are for more weakness. However, less bad may be good.
Wednesday’s retail sales number is expected to climb nearly 1%. A strong consumer reading is important going into the Christmas shopping season.
Along the same lines, the week in corporate earnings will take a retail swing, with Walmart (WMT), Lowe’s (LOW), Home Depot (HD), TJX Companies (TJX), Ross Stores (ROST), and Target (TGT) on the docket.

Overseas

A 3rd Quarter Gross Domestic Product (GDP) reading from Japan and the European Union shouldn’t surprise the markets with a tiny expansion. The United Kingdom, while not reporting GDP, will be a significant driver of news flow.

The U.K. is poised to report a 10.6% consumer inflation reading year over year, coupled with a 6.5% percent decline in retail sales.
More importantly, the budget statement from the new Prime Ministers is expected to focus less on borrowing than the previous administration, which is viewed as a positive development.
Retail sales and industrial production from China are probably worth a look as well.

The In-Between, is Still in Between

The U.S. elections on Tuesday of last week did not result with all winners declared, so we await results from several key races into the new week.

As we write, four Senate races have yet to be determined, with one now going into a runoff in December.
The Nevada and Arizona Senate races may swing control of the Senate, avoiding dragging out the suspense to December.
Of the 435 House of Representative races so far, 408 have been called, leaving 27 still in the air.
Republicans need to take seven of the remaining races to take over control.

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