Research.LeutholdGroup

Inflation surprises have run hotter in the U.S. than in the rest of the world, no doubt reflecting the strength of major currencies versus the U.S. dollar. 

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When measured by the gains in stocks, gold, and house prices, there has been just one other occasion in which asset inflation was as “broad” as today—late 1980. But the differences in underlying fundamentals between then and now couldn’t be more stark. 

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Knee-jerk contrarians are already claiming the stampede in Small Cap stocks is “too consensus” to continue in the near term. We couldn’t disagree more. In fact, we are very confident that a new multi-year Small Cap leadership cycle has kicked off.

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“Don’t fight the Fed” has been great advice for stock market investors over the last nine months. For 2021, that won’t cut it. It should be: “Don’t believe the Fed.”

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We’re still coming to grips with Modern Monetary Theory and the stark realization that “the delusional is no longer marginal.”

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The big jump in Small Caps over the last two weeks has entirely reversed the segment’s summer underperformance and has technicians feverish about another “breath thrust.” Technically, it’s impressive, but we are more intrigued by the fundamental potential for continued Small Cap (and Mid Cap) outperformance.

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Long before policymakers’ extreme response to the COVID collapse, we feared that the Fed’s interventions were suppressing important signals from the stock and bond markets. But we now suspect that hyper-expansionary policies are suppressing price signals from the “real” economy as well.

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The Fed is hell-bent on generating inflation of 2% or higher in an over-supplied world that we think should probably be experiencing mild deflation. Their success or failure at this mission will be critical for asset allocators. For equity managers who must remain fully invested, however, the more important question might be not whether the Fed can generate higher inflation, but where.

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Where inflation goes next will be primarily determined by the probability of a recession.

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In the aftermath of the Great Financial Crisis, we reminded investors that it would be historically unusual for the thematic leaders of a bull market to repeat as the winners of the subsequent bull.

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Two words sum up the past decade pretty nicely: U.S. Exceptionalism. The superiority of U.S. assets really comes down to the unique combination of growth (U.S. stocks), yield (U.S. bonds), and relative safety (both U.S. stocks and bonds).

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We put together an Inflation Scorecard that monitors two critical sets of inflation drivers: demand pull and cost push. The qualitatively-adjusted score is much closer to a neutral reading than the mechanical composite (which suggested quite a bit more disinflationary headwind).

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Just a few months ago, Fed Chairman Jerome Powell boasted a reputation as a straight-talking, sound-money banker.

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Wage inflation should accelerate in the months ahead, oil could bounce from its oversold low, and college textbooks might double in price before the fall semester. No problem…

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The latest CPI numbers missed market expectations. The problem is not with the actual CPI numbers, but merely the fact that market expectations are still a tad too high. More disconcerting is the cool trend in housing inflation.

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The year-over-year headline number was in line with market expectations but the month-over-month increase missed market consensus (0.1% vs. 0.2% expected). All else being equal, there is a good chance CPI might have peaked for 2018. A stronger dollar is disinflationary while the short term impact of tariffs is higher import prices.

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After yet another benign figure on wages for June, the idea that inflationary pressures might be a problem for the stock market seems far-fetched.

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Headline and Core CPI figures hit estimates right on the nose in May, continuing the trend of modest but not outrageous price increases. Energy prices have boosted headline CPI while core CPI continues to be driven by services. With both of the Fed’s mandates pretty much accomplished, appreciate this rare window of time.

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Consumer Staples has historically been the sector most resistant to intermediate stock market corrections, exhibiting an average “downside capture” of less than 40% during all such declines dating back to 1989.

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The first quarter S&P 500 earnings “beat” rate stands to be the highest in history, as any CEO with a pulse has learned to lower the hurdle.

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For the first time in this bull market, defensive stocks failed to provide any semblance of defense during a market correction.

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The setback that began in late January qualifies as the sixth intermediate correction of the current bull market, where “intermediate” is defined as an S&P 500 loss ranging between 7%-12%...

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The headline and Core CPI numbers for January both came in hotter than expected. Despite the resurrected interest and concerns about inflation we still haven’t caught inflation fever. Because of the narrative (correct or not) look for increased volatility surrounding inflation announcements.

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So, what happened to the January Barometer—the old analyst’s maxim that a market gain in January portends a gain for the full year?

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The latest Core CPI number beat expectations but the yield curve flattened. The market shows more conviction about the Fed’s rate hikes than longer term inflation. We recommend patience and we don’t believe missing out on the first few months of higher inflation will cost us dearly.

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While our Group Selection (GS) framework hasn’t yet warmed up to commodity-oriented industries, our macro work suggests perhaps it should.

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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.

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While the bull possesses a seemingly endless supply of energy, the Leuthold database still houses a supply of measures by which the bull market has fallen short.

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If we look beyond the daily noise from North Korea, the global macro picture still fits our “Goldilocks” view pretty well.

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While the next recession could be caused by a variety of factors, we suspect the recovery will eventually end like most post-war expansions, only after a significant rise in interest rates.

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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.

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Leading inflation indicators have leveled off so far in 2017 after last year’s huge rebound from the deeply oversold readings produced by the 2014-2015 collapse in commodities.

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The best interpretation of the current cross-asset message is the scenario of goldilocks, and there are reasons to believe this is a possible scenario for the near term.

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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.

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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.

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For managers who must remain fully invested in equities (or “paid to play,” as we’ve often called it), the level of inflation might prove a less important consideration than its character.

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We should emphasize that any inflation pickup is likely to be a traditional, late-cycle phenomenon stemming from rising wage growth and rebounding commodity prices. We do not expect a secular move toward significantly higher inflation rates (say, north of 3.0%-3.5%).

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Over the last 70 years, stocks have made no cumulative progress when Producer Price Inflation runs above 4%. Returns have been average when PPI inflation runs between 2% and 4%—where it is today.

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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.

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· One bright spot in last month’s lackluster market action was that inflation sensitive assets saw impressive relative returns.

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