Stocks traded lower on Friday after a hot Producer Price Index / PPI resurrected ghosts from the past. University of Michigan Sentiment showed that respondents are raising their expectation of inflation in the future.
Ghost busters. Were you getting out of town on Friday ahead of the President’s Day weekend? Schools are out, kids and grandkids are off, and surprisingly, even here in the northeast we have some snow in the mountains worthy of skiing. Maybe you headed for some warmth down south, though Florida disappointed with less-than-sunny conditions. I was glued to my screens on Friday watching the market throw a bit of a temper tantrum. The weather in the market was anything but warm and sunny and far from fit for winter fun. Hopes for a happy go lucky, rate cutting Fed are cooling off and approaching their freezing point.
You see, the Producer Price Index / PPI came out much hotter than expected. In this case, hot is not good 😉. The reason is the PPI is a leading indicator of CPI. When producer prices are going up, consumers are likely to pay the butcher’s bill down the road. You can’t expect rational companies to allow their margins to suffer. No, that burden is ultimately on us… you and me. A side note on that. The biggest gains came in services, once again, and it has a lot to do with the tight labor market.
Does this seem like old news to you at this point? Wouldn’t it just be more fun to talk about Elon Musk launching a Tesla into space? Don’t worry fellow travelers, those days will come again soon, but not until we eradicate all the inflation ghosts from the past. “Wait, did he just say ghosts,” you ask? Yes, my friends, I did. Take a look at this chart, then keep reading.
This is a chart of CPI in the 1970s through early 1980s. You can see inflation reaching over +12% in 1975. Just as it appeared to be extinguished in 1977, things took a turn for the worst and inflation came back with a vengeance topping out at +14.8% in 1980. Freshly assigned inflation fighter Paul Volcker was sworn into the Fed Head position just a year earlier and he did what needed to be done. That being raising the Fed Funds rate to 20%! That caused a recession. Volcker responded with rate cuts back down to 10%, but inflation did not go away and was still above +12%. What we had was stagflation, which is a receding economy topped with inflation… not good. Volcker had to do the unthinkable. He had to raise rates once again back to 20% three more times and cause another even more painful recession before inflation was finally put down. The surviving message from that passage of history was that Volcker was too quick to cut rates in early 1980, despite the recession.
Imagine, this very portrait of Paul Volcker painted by Luis Alvarez Roure hanging in the FOMC boardroom. This along with his ghost haunts today’s Fed warning of hasty rate cuts. He looks serious, doesn’t he? The Fed does not want a repeat of the early 1980s, nope. That is why Fed members will drag their feet as long as they can, even risking a recession. Don’t believe me? Just look at that portrait one more time.
Unfortunately, it is not all that simple. You see, this morning WHILE YOU SLEPT, Home Depot released its earnings. The company beat low bar estimates but recorded a 5th straight quarter of sales declines. Those sales declines are a direct result of higher interest rates. You see, rate hikes that started 2 years ago (THAT’S RIGHT) are having effects today. The takeaway here is that controlling the economy is more like piloting a full cargo ship than a Formula 1 racecar. Turning on a dime is simply not possible, typically resulting in investors losing many, many dimes in the process.
WHAT’S GOING ON IN THE PREMARKET
Discover Financial Services (DFS) shares are higher by +14.49% in the premarket after Capital One Financial (COF) announced that it would acquire it for +35 billion. The acquisition price represents a +26.6% premium over Discovery’s last closing price. Capital One is trading lower by -3.81%. Dividend yield: +2.5%. Potential average analyst target upside: +6.5%.
Medtronic PLC (MDT) shares are higher by +3.81% in the premarket after announcing an earnings miss but raising full year profit guidance. Medtronic’s forward PE of 16.35x is lower than the median 21.66x of its peer group. Dividend yield: +3.26%. Potential average analyst target upside: +9.7%.
FRIDAY’S MARKETS
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