Today’s inflation report was pretty brutal across the board.
The headline number was the year-over-year increase in CPI (consumer price index) of 9.1%, the highest in 41 years. That takes us back to 1981 and the heart of the legendary inflation problem and sky-high interest rates which finally broke its grip. Not the kind of company one wants to keep.
The monthly number was arguably worse, not in its historic scope, but in terms of its implications. That’s because with the annual figure, it’s easier to argue over "base effects" and the impact of changes since the starting point a year ago. But with the monthly number rising 1.3% in June after being up 1.0% in May, it’s harder to make any argument that inflation is decelerating. It’s not, it’s still accelerating.
The monthly increase in CPI was the worst since September 2005, so at least that’s not quite as devastating a comp as the annual figure. The only other silver lining, such as it is, is that surging energy prices accounted for a big portion of the increase, and energy prices have fallen markedly over the past month. So there’s at least hope that lower energy prices will translate into relief soon for that monthly measure.
Implications for the stock market
To my eye, this is an important, bad report for the stock market. So it’s surprising that stocks have rebounded after a sharply lower open.
The reason I think it’s so significant is that over the last month or so, investors have increasingly focused on the rapidly rising risk of recession after spending the past year or more focused on runaway inflation. The growth slowdown has become more obvious seemingly by the day, reinforced by nearly every new economic data point and sentiment survey. So it hadn’t taken much of a mental leap for many investors to hope this steady drumbeat of worsening economic news would influence the Fed to back off its tightening of financial conditions.
Today’s inflation report is a dagger through the heart of that idea.
It’s very hard to imagine the Fed pivoting in any substantial way until these headline CPI numbers retreat much closer toward the Fed’s stated 2% annualized target. As I just noted, they’re currently not retreating at all — the monthly number is still accelerating.
The rates market clearly agrees with that interpretation, as the odds surrounding the size of the rate hike at the July Fed meeting in a couple of weeks shot higher immediately upon today’s CPI release. The market had been backing away from a 0.75% hike and pricing in an increasing probability this month’s hike could come in at just 0.50%. But after today’s report came out, those odds started shifting in favor of a full 1.00% hike, with 0.75% the new minimum.
While a less-aggressive Fed may not have been the only reason investors grew more optimistic on stocks over the past month, it was a primary one. With that hope dashed, it wasn’t surprising to see stocks take a significant hit at the open this morning. What has been a bit surprising is that they’ve bounced back as the day has progressed.
I don’t have a good explanation for that, but initial responses to Fed/inflation-type moves have been...unreliable...lately. The past two Fed meetings have seen big market rallies the day the Fed hiked rates, only to give it all back the very next day (after investors supposedly "had time to think it through" or some such). So we’ll see.
Earnings season is the next catalyst?
Tomorrow, second-quarter earnings season kicks off in earnest with JP Morgan reporting. The next three weeks or so will see most major companies reporting their second- quarter earnings, and perhaps more importantly, providing guidance as to what investors should expect in the second half of 2022. I expect the earnings (backward-looking) to be okay, while the guidance (forward-looking) is pretty bad. For several weeks now, I’ve anticipated this earnings season could mark the beginning of the next leg lower for stocks.
If that ends up being accurate, the good news is that SMI investors are well-positioned to withstand more market downside.