Frequently, there’s money to be made in the stock market in the months following the initial curve inversion. After the inversions of August 2006 and June 2019, the S&P 500 rallied another 23% and 19%, respectively, into its final bull market high. If this cycle plays out in textbook fashion, the business-cycle peak would arrive in September.
Boy, were the pundits ever right about the Roaring Twenties. Less than three years into the decade, the animal they fear most has already roared two times. Actually, the first one, in the first quarter of 2020, was more like a piercing “yap,” taking the S&P 500 down almost 34% in just 23 trading days. The second roar has been a deeper, more guttural one that’s lasted nine months and is probably not done.
PPI and CPI inflation reached levels that were “too hot to handle” last April and July, respectively, yet the blue chips kept going up through year-end. Large Cap investors who trimmed stocks in response to the violation of these long-time inflation speed limits, however, haven’t missed out on much, and Small Cap investors who did so are happy.
We don’t profess to be professional inflation forecasters, but are struck by a sort of “temporal” mismatch in the arguments used by those who believed the inflation pick up would be temporary. Specifically, the most commonly-cited bullish inflation arguments have been secular in nature, based on long-term trends in technological innovation, demographics, and free trade.
With consumer price inflation raging at 6.2% and few indications of an imminent rollover, Jay Powell has waved the white flag and retired the ill-begotten “transitory” descriptor. The timing of Powell’s concession is intriguing—perhaps he’s a fellow follower of a simple inflation model: the Output Gap.
Last week we argued that U.S. money growth remains way too high to reasonably expect a peak in consumer price inflation during the next few months. At the peaks of the last five bouts of inflation of 5% or more, real growth in the M2 money supply had turned negative in four cases and had slipped to less than 1% in the other one. Today, real M2 is growing at nearly a 7% rate.
Fifty years ago this month, Richard Nixon formally suspended the convertibility of U.S. dollars into gold. Editorials commemorating this have tended to have a celebratory tone, and why not? Abandoning the gold standard greatly expanded the arsenals and imaginations of policymakers, both of which have been on historic display over the last 18 months.
At some point during the June/July streak of seven-consecutive S&P 500 daily-closing highs, an album from 1980 popped into our heads: Nothin’ Matters And What If It Did—released when John Mellencamp was still known as John Cougar. It brought to mind some “nothin’s” that seem not to matter.
Consumer Price Inflation of 1.2% for the twelve months through October remains way below the Fed’s long-time 2% objective, which is nothing new. But a first step in getting inflation to eventually run a little bit “hot” (the Fed’s new objective) is to break the long-term disinflationary psychology among consumers and investors, and that is clearly happening. In fact, based on the excellent “Inflation Surprise” Indexes published monthly by Citi, the U.S. is now the world’s inflationary hotspot!
The latest Core CPI number disappointed again. The divergence between inflation break-evens and the yield curve is puzzling. Given the lack of inflationary pressure and the Fed’s projected rate path, it would not surprise us to see a flatter curve without the help of fiscal stimulus in the next few months.
The CPI numbers have disappointed three months in a row. Weak commodity prices do not inspire higher inflation expectations. The global scope of inflation deceleration adds more weight to the recent soft readings. However, lower bond yields relative to nominal growth rate is inflationary and buffers the impact of weak inflation and rate hikes.
The latest CPI is weaker and the softness was sooner than we expected. More alarming is the recent broad-based deterioration in economic data. Lower inflation expectations have flattened the yield curve recently, which hurt Financial stocks. We believe inflation has likely peaked for the time being and patience is the right approach for the reflation trade at this point.
The dovish rate hike is a positive for inflation and credit. A hawkish message right now would have been quite detrimental and self-defeating in terms of realizing two more hikes later this year. We believe achieving sustained 2-3% inflation could be harder than most people expect going forward. Overall, we are encouraged by the dovish hike but we think the real test for inflation is when the base effect starts to wane.
CPI numbers were strong and better than expected. A big part of the recent upturn in inflation has to do with the much lower base from a year ago. We are seeing upside inflation surprises on a global basis but wage inflation is still disappointing. We are encouraged by the general uptrend in inflation data but we think the real test comes after the positive base effect subsides.
CPI figures for December matched consensus estimates. The Federal Reserve should be pleased to see the modest uptrend in prices. Sustained price inflation still faces a number headwinds including: resource slack, a strong Dollar and a weakening Yuan. Energy prices saw the largest gains in 2016 after a brutal 2015. Within the Core CPI, medical care experienced notable gains.