Stocks traded lower yesterday after a scorching-hot CPI number took economists by surprise. Investors begin to contemplate an even larger rate hike later this month.
Hit me with your best hike! Let’s get this out of the way first. We all know that inflation is a thing. You don’t have to read the financial times or even my daily market note to know – it’s real and it’s palpable. That said, are you surprised to know, according to yesterday's Consumer Price Index / CPI, that the annual inflation rate is +9.1%? Economists were expecting a somewhat lower, but still quite high, +8.8%, so the release took the market rather by surprise. That is the highest year-over-year growth in over 4 decades. Check out this chart to get a visual perspective on it.
What is costing us more, according to the latest report? Food is a big culprit. The cost of Flour/Prepared Flour Mixes, Meats/Poultry/Fish/Eggs, Dairy/Related Products, and Butter/Margarine cost more by +19.2%, +11.7%, + 13.5%, and +26.3% over last year, respectively. Of course, there is the usual suspect Motor Fuel, which is now higher by a whopping +60.2%! In a similar vein, you are paying +38.4% higher for your Utility (piped) Gas Service and +13.7% more for Electricity. There are plenty of other items which posted eye-watering gains, but I highlighted the ones that most of us require for our daily subsistence. You can put off that haircut for a few weeks, postpone air travel, and possibly even cancel that New Yorker subscription (you barely have time to read it through, anyway). They all jumped in price as well, but the ones listed above apply to most of us. Did I mention that Health Insurance is more costly by +17.3%? Ok, you probably suspected that but now you know the actual numbers. Forget about how these jumps in costs occurred, how are we going to bring prices back into check?
That is the job of the Federal Reserve. The Fed has certainly been on the inflation fighting track since late last year when it started talking about rate hikes. Now we have a few of those hikes behind us, and the Fed is largely expected to follow up with another larger one later this month in its FOMC meeting. Just a few short weeks ago, traders began to believe that the Fed would slow its hikes in response to weaker economic conditions. It was thought that, perhaps the central bankers might choose to raise their key lending rate by only +50 basis points this month instead of the previously expected +75 basis points. Well, you better believe that hope has been tossed out the door. According to Fed Funds futures, as of this morning, the market has priced in a 100% chance of a +75 basis-point hike, and a…wait for it…70.3% chance of an additional +25 basis-point hike. Anything over 50% is probable so, according to futures a +100 basis-point hike is now probable. Just 2 days ago, futures predicted a 0% chance of the additional +25 basis-point hike. What does that mean for the economy?
Remember that higher borrowing costs resulting from Fed hikes is simply additive to the budget pain already being experienced by consumers. The theory is that the additional pain will cause consumers to simply demand less, thereby causing prices to ease. In other words, we must get pain if we want some gain. But how painful will it get? If you ask the bond market, it will tell you that it is expecting the possibility of a recession. The yield curve between 2-year and 10-year Treasury Notes has been and is now firmly inverted. That means 2-year yields are higher than 10-year yields. That yield curve inversion typically occurs before a recession. Economists, however, are still not convinced that the US will enter a recession. On median, the leading group of investment bank economists believe that there is just a 30% chance of a recession in the next year. That probability has been constant since mid-June. What does that mean for the already besieged equity markets?
Equities have had a tough go at it since the Fed first announced its intention to apply the brakes to the economy last November. Volatility has been extraordinarily high for an extended period, and losses have been painful across the board, regardless of corporate performance. The equity markets were factoring in first, the higher rate environment, and second, the possibility of an economic downturn. For stocks, that means lower growth trajectories for earnings growth, which, quite plainly, means lower stock prices. Many analysts believe that the bulk of the selling is behind us and while volatility is still high, its has moderated significantly since last month. Finally, yesterday’s CPI report reflected prices in June… last month. There are some signs that prices have moderated since, albeit small ones. Crude oil is some -21% lower than it was in June and, according to AAA, the national average price of gasoline is down by around -7.5% since last month. Today marks the beginning of earnings season. Similar to the CPI, earnings releases will be backward looking, reflecting activity from March through June, so we must put them into perspective. More important than the past quarter’s performance will be the commentary surrounding the releases. Lowering expectations with forward guidance changes will be signs that companies are experiencing some pain and preparing for tougher times in the coming quarters. As you will note from the chart above, inflation got better and remained in control for many years after 1981…and you will also note that it was far worse before it got better. Hang in there, stay focused on your long-term objectives.
WHAT’S SHAKIN’
JPMorgan Chase (JPM) shares are lower by -2.87% in the premarket after it announced this morning that it missed on EPS and Revenue estimates. The company referred to the war in Ukraine, inflation, and economic uncertainty as slowing factors. The company further, suspended its share buyback program to comply with stress tests. Dividend yield: 3.57%. Potential average analyst target upside: +29.3%.
Morgan Stanley (MS) is lower by -1.81% in the premarket after it missed on EPS and Revenue estimates by +8.31% and -1.46% respectively. The company’s investment banking revenues are lower than last year’s while fixed income revenues are higher as would be expected in a highly volatile market. Dividend yield: 3.73%. Potential average analyst target upside: +29.6%.
YESTERDAY’S MARKETS
Stocks traded lower in a volatile session after CPI came in far hotter than expected. The S&P500 traded lower by -0.45%, the Dow Jones Industrial Average sank by -0.67%, the Nasdaq Composite Index slipped by -0.15%, and the Russell 2000 Index pulled back -0.12%. Bonds gained and 10-year Treasury Note Yields slipped by -3 basis points to 2.93%. Cryptos gained +1.89% and Bitcoin advanced by +1.10%.
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