Fears Become Reality

Fears become reality.  Stocks experienced a major rout yesterday when a greater than expected Consumer Price Index number prompted selling.  Higher bond yields resulting from the big inflation print accelerated the buying in growth stocks, whose valuations are affected by rising bond yields.

N O T E W O R T H Y

The things that go bump in the night.  I am not one of those guys that says “you can’t say I didn’t warn you,” but… I did.  To be clear, I am not the only Wall Streeter talking about inflation lately.  In fact there are lots of us, but I like to provide my readers with an inside take, so that you can avoid media-hyped headlines scaring you to hide under your bed. Speaking of hyped-up headlines, there are plenty of them floating around.  “Inflation through the roof!!”, or “Get ready to pay more for a loaf of bread”, or “It’s the 1970s all over again”.  I couldn’t blame a writer for using headlines or taglines like that.  Writers employ those headlines to hopefully, lure a reader to read the well… whole article.  Granted, some of those articles can get quite long, and in these days of instant everything, who has time to read big articles about boring topics like inflation and bond yields?  I get it, that is why I make sure to read the entire articles and, in many cases, even check the facts… it’s my job, after all. Some economic number releases are really not technically a number but rather a series of numbers. What I generally report to you and what you might see when you log in to your favorite news site or brokerage app, is what we refer to as a headline number.  That is usually a single number that is a culmination of the series of numbers being released.  Take, for a timely example, the Consumer Price Index, or CPI. Yesterday, CPI came out with an eye-catching beat of a +4.2% annual change. Economists were expecting it to be high, somewhere around +3.6%, which is already high considering that the Fed often talks about its +2.0% target.  In any case, the +4.2% headline inflation number is one of the key drivers of yesterday’s selloff in stocks AND bonds.  If you simply read that number, it may have gotten your attention… the headline inflation number is the highest since 2008!  Ok, so I have set this up long enough.  Let’s get below the surface for some important facts.  Food and energy prices can be volatile.  Supply and demand issues cause prices to go up and down frequently, which is why most economists prefers to look at a basket of goods that does not include those items. That number is often referred to as Core Inflation in the case of yesterday’s release, the number is CPI Excluding Food and Energy… you can’t get more descriptive than that. That number came in at +3.0%, also above economist estimates, but far lower than the scary +4.2% headline number. Ok, so let’s get even further into the depths of the release.  Simply looking down all of the different components of the monthly changes, we see standout increases in Used Cars / Trucks, Admissions to Sporting Events, Car / Truck Rental, Lodging Away From Home, and Airfare.   Large increases in those categories should immediately jump out at you as prices being affected by the reopening of the economy.  So what of it?  Remember that the headline CPI number shows price changes from a year ago.  You remember, when the economy ground to a halt.  Airfares and hotel room rates were sinking due to lack of demand.  Vehicle sales spiked down to levels not seen since just after the last recession causing prices to drop.  Tickets for sporting events?  Well, I will let you be the judge of that one. Anyway, the economy’s return to normal-ish has certainly caused demand to increase for those things that were low on the priority list in the depths of lockdown.  Prices for those items are returning to normal, so one would expect year over year increases to spike.  In other words, last years lows were an anomaly, while this years prices are more in line with reality.  So, can we assume that Admissions to Sporting Events is going to continue rising by +10.1% every month going forward?  Well, no, it’s not likely.  Inflation is always a sign of an economy that is running hot.  In this case, a hotly running economy, one running hotter than last year is something that we all would like to see, and the year over year inflation is a sign that things are better than they were last year at this time. Now that you know how the headline numbers are calculated, you probably understand why the Fed is insistent that any inflation right now is transitory.  Oh, and remember when I mentioned earlier that annual inflation wasn’t this high since 2008?  That is true, and it actually spiked even higher a few months before.  You might think that the Fed was worried about those big numbers back then.  They probably were, but they didn’t hike interest rate until 2015… 7 years later. Quantitative easing tapering didn’t occur for at least another 5 years either!  So, while the Fed may be concerned with higher prices impacting demand, its track record shows that the Fed can be patient, and any near-term change of policy is still less probable.

THE MARKETS

Stocks took a drubbing yesterday after the headline CPI number came in far higher than expected. The S&P500 fell by -2.14%, the Dow Jones Industrial Average dropped by -1.99%, the Russell 2000 Index gave up -3.26%, and the Nasdaq Composite Index sold off by -2.67%.  Bonds fell and 10-year treasury yields climbed by +7 basis points to 1.69%.

NXT UP

– PPI Excluding Food and Energy YoY (April) may have risen to 3.8% from 3.1%.

– Initial Jobless Claims (May 8) is expected to come in at 490k, down slightly from last week’s 498k claims.

– Today’s Fed speakers include Barkin, Waller, and Bullard.  Expect inflation comments by them.

– After the bell we will hear from Disney, Coinbase, DoorDash, GoodRx, Airbnb, and Luminar.