Thursday, December 8, 2022

Inflation Heading Down, What Happens Now?

By on November 14, 2022

The Four Benchmarks to review that confirm inflation may be trending down

As the Consumer Price Index fell more than anticipated to 7.75%, the markets reacted with intense gusto recording the best gains in two years. However, while we welcome the news, we must comment that one monthly decrease does not constitute a trend; we have stated in other columns that the Fed would wait to pivot its monetary policy following three or four CPI decreases. It took four consecutive 0.75% rate increases by the Fed to finally move inflation lower, while, as we said, not still a trend; it may be possible that the Fed may slow the pace of increases to a range of 25 to 50 basis points on the December FOMC meeting.

Following the confirmation that the CPI and Inflation reading fell further than expectations, we must discuss other areas of the economy where we see further inflation pressure trending down. 

  1. Housing and Mortgages: for one, the housing market has fallen more than 20% as mortgage rates have risen to 7.08%; while this is not expensive, it is still lower than the long-term average of 7.76%. The problem is that mortgage rates have been hovering between 3% to 4% for a decade, and the adjustment takes time. Also, most prices of homes are trending down and will continue to go down for a while, and it should show up in later CPI readings.
  2. Supply Chain Normalization: as the supply chain chaos is normalizing, we see evidence of transportation prices falling and systemwide capacity rising for the holidays. The shipping rates from Asia to the U.S. and Puerto Rico have fallen some 75% from their highest point. Also, the Global Supply Chain Pressure Index fell to 1.001, up from 3.810 one year ago. a decrease of -73.73%.
  3. Jobs and Wages: one of the drivers of inflation growth was higher wages to allure employees to return to work, the is falling fast, and we shall see a softening of the labor markets. We have already sung some signs as many tech companies have announced rounds of thousands of layoffs. While it is true that job creation remains solid, the total number of job openings has fallen from as high as 11.86 million on March 2022 to 10.72 million in September, a decrease of 1,140 million, evidence that parts of the economy are feeling the effect of the interest rates increases.  
  4. Holiday Retail Sales:  the National Retail Federation released its Holiday Sales 2022 forecast, predicting a sales increase of 6% to 8%. 

The Week in Markets: The CPI veers down to 7.75%m while FTX $32 billion plus bankruptcy further impairs crypto assets and Wall Street closed up.

The U.S. stock markets closed the week with positive results recording the best week in two years. Not even the bankruptcy $32 billion filing of cryptocurrency billionaire Sam Bankman Fried’s company FTX or the U.K. 50% decrease in GDP derailed the gains. The FTX bankruptcy saw Sam Bankman Fried’s net worth recorded on Monday to be $16 billion to near zero following today’s filing and unfortunate end. 

Last week’s lower-than-forecasted Consumer Price Index of 7.75% provided investors with much-welcomed news and the ultimate hope that the Federal Reserve Bank would position its monetary policy towards a less aggressive stance, which remains to be seen. The other positive development was that the U.S. Core Consumer Price Index fell to 6.31% and which excludes food and energy fell more than expected.

As the CPI fell lower, stock markets rose, U.S. Treasury yields fell, and the U.S. dollar closed lower, indicating that the inflation reading is the main issue affecting markets.

Wall Street Weekly Summary for the week ending November 11:

  • Dow Jones Industrial Average closed at 33,747.86, up 1,344,64 points or 4.15% and YTD Retun            -7.13%.
  • S&P 500 closed at 3,992.83, up 222.28 points or 5.90% and YTD Return -16.22%.
  • Nasdaq Composite closed at 11,323.32, up 848.06 points or 8.10% and YTD Return -27.62%.
  • Birling Capital Puerto Rico Stock index closed at 2,762.47, up 106.27 points or 4.00% and YTD return -4.05%.
  • The U.S. Treasury 10-year note closed at 3.82%.
  • The U.S. Treasury 2-year note closed at 4.34%.
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The recovering looks more like a “U” than a “V.”

The latest GDPNow Update for the Fourth Quarter forecast is 4% GDP, an increase of 11.1% from its previous forecast of 3.6%, and it is the most robust evidence following the third quarter 2.60% GDP that the U.S. economy is on track for a strong recovery. 

This data and the CPI number allowed the markets to change from pessimistic to optimistic, at least during the last week, and it recorded the best trading week since 2020.     

As policymakers, traders and investors begin to adjust their bearing to trending down inflation, the change in sentiment will force the bond yields down while promising a sustainable recovery. But from the data we have studied, we think that a “U” shape recovery is more likely to occur; however, be mindful that volatility will continue while the inflation data become a trend rather than a monthly occurrence. Moreover, the Fed has made a solid effort to take inflation to its 2% target, so we do not foresee the Fed altering its path until it feels that inflation is headed toward its target.

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One Last Lesson: Shift focus from Defensive toward Growth

For the past few weeks, we have stated that this is the right time to change investment focus from defensive towards growth. 

As markets shift into growth mode, we start to see lower yields on bonds and an increase in gains on most equities, and given the lower prices, we are seeing that create a compelling opportunity for growth. 

For example, suppose you had invested $10,000.00 last week; these would have been your gains using each index as a guide:

  • Dow Jones: Had you invested $10,000, your gains this week would have been $415.00.
  • S&P 500: Had you invested $10,000, your gains this week would have been $590.00.
  • Nasdaq Composite: Had you invested $10,000, your gains this week would have been $810.00.
  • Birling Puerto Rico Stock Index: Had you invested $10,000, your profits this week would have been $400.00.

As The Oracle of Omaha Warren Buffet says, “Be fearful when others are greedy, and greedy when others are fearful.”