Whipsaw action ramped up after April CPI reports showed a much larger than expected increase in prices across the board on Wednesday. Although everyone was expecting one of the stronger yearly inflation reports in decades, not many were expecting month over month trends to rise 90bps, the most since 1981. It is also the first time we’ve ever recorded six straight months of accelerating rises in the CPI. Year over year was 4.1%, which makes sense when compared to a Covid – induced shutdown in 2020 and oil prices going negative. However, monthly increases are more critical today, and came in nearly 4X higher than economists predicted relative to prices in March.
Used car prices led the way, rising 10% from last month. Semiconductor supply chain issues are holding back several million cars from being made, causing prices to rise for used cars as well. Our expectation is this will be fixed over the coming months. Whether that is 2 or 10 months matters little to the long-term outlook on inflation. Reopening industries also had decent increases with airfares, hotels and education goods rising 10%, 8% and 3%, respectively. Vaccinations are giving consumers confidence to book a vacation or get their kids back into classrooms. We can only reopen once though, so this too should be transitory. Available airline miles are still 30%+ below pre-pandemic levels. More planes are coming.
Pricing gains were broad-based in products that are disrupted by supply issues, signifying the overall global disturbance affected many other products as well. Refrigerators, patio furniture, couches, washing machines and bicycles are still hard to find for desired models. This raises prices across the board. Even the heavily important owners’ equivalent rent came in stronger than expected. Bottlenecks in finished goods, labor shortages and monthly comparisons in reopening industries continue to look like a near-term supply/demand imbalance that will be corrected over time.
At least that is the Fed’s hope today. Market concerns center over how long this lasts and if price increases continue, and if that will lead to sooner than expected taper talk and an increase in short-term interest rates. After several trillions in stimulus and a likelihood for even more to come, this once-in-a-generation approach to Modern Monetary Theory could lead to a more persistent shift in pricing dynamics. That is not our base case, but certainly in the world of possibilities. Monitoring Fed speeches from here will be a necessary talent in order to position for an eventual pulling back of the punch bowl. Stocks are pricing some of this in today. Even with the relief rally yesterday, many go-go growth stocks finished in the red.
However, slowing down the Fed’s $120B monthly bond purchases or raising Fed Funds by a quarter point is hardly disastrous for equities over the long haul. Far from it. Imagine telling an investor in 1981 that markets are concerned about inflation with a 10-year Treasury at 1.7%. Looking throughout history, initial reactions to a change in Fed posture result in an immediate ~5% decline. From there it’s back to new highs and then some. At this week’s lows, the S&P was down 4.3% from recent highs. The growth heavy Nasdaq dropped 8.5% as well. This is normal action.
Chart time! As an example of typical reactions coming off recessionary lows, let’s look back at the last drawdown and recovery from the Great Recession in 2008:
Coming out of the 2009 lows, the S&P rallied nearly 80% in 14 months before consolidating gains for half a year before doubling over the next four years. Today, we’re up 80% since last March and starting to see a pick-up in volatility. Since we’re entering a seasonally weaker period, one shouldn’t be surprised with more back-and-forth action while economic data comes in hot on the inflation front. As Jim Meyer noted, we’re in a news vacuum. The majority of corporations already reported Q1 numbers and we won’t hear how great Q2 is until late July.
Subpar employment data, coupled with higher than expected inflation does not help bulls. It is quite possible our next update reverses this trend but investors are becoming more cautious today. Again, this is normal and actually healthy for the next leg of our advance.
Items to keep an eye on:
- 10 year Treasury yields – any breakout above March highs of 1.76% could bring more “growth” stock selling pressure. It closed at 1.67% yesterday.
- March lows – several stocks are handily below the last mini-correction price lows from March. The bulk of these are zero earnings, sky high P/E ratio companies, IPO’s and SPAC’s. That bubble has already popped but more pain can be had if rates break out on the upside. An S&P level to watch would be 3950 for higher quality stocks.
- New highs – a rarely used indicator that I’ve found successful over the years are climaxes. In short, when a stock makes a new yearly high but closes down on the week, it is said to have a Buying Climax. This is a sign of institutional demand drying up. When it occurs in groups, it is even more powerful. Depending on how the market closes today, we could have a massive number of stocks showing buying climaxes. More than 44% of the S&P set new highs on Monday, the most since 1943. Many are down 5% from those levels already. Today’s close will be important from a technical standpoint. A solid positive day would be welcomed news.
- Fed speeches – Fed heads are coming out noting they were “surprised” by the CPI report. Time will tell if that means an end to bond purchases or any hint of raising Fed Funds. Since they have a dual mandate of stable inflation and maximum employment, they can remain steadfast in goosing the economy until the unemployment rate ticks back down. This will take months to accomplish.
- Oversold conditions – The last time the Nasdaq was this oversold was back in March before a 15% rally ensued. That index has dropped back to its 200 day moving average, also for the first time since March.
The end result is much of the same. Hot stocks with negative earnings are in no-man’s land. Interest rates are pointing upwards. Inflation is here but should subside. Inflation may last a few months longer than many hoped but supply chains get fixed and we can’t reopen twice. Valuations, cash flows and predictable revenue stream companies are acting fine, although they may have gotten slightly ahead of themselves. Inflation beneficiaries are winning today but it won’t last forever. Look for world-class operators and pick a price. This bull market isn’t over. These corrections can last another week or several months but markets do not peak until earnings do. We’re far from that today.
Facebook founder Mark Zuckerberg is 37 today. Star Wars legend George Lucas is 77. Movie star Cate Blanchett turns 52 while football great “Gronk” is 32.
James Vogt, 610-260-2214