Not Yet Time For The Victory Lap

Telemus Weekly Market Review August 8th - August 12th, 2022

This week the Bureau of Labor Statistics reported that inflation, as measured by the Consumer Price Index (CPI), was flat in July, stemming a year and a half trend of climbing prices. Markets cheered this announcement, as the S&P 500 gained 3.3%. The tech heavy NASDAQ jumped 3.1% and its recovery now exceeds 20% off its low, establishing a technical return to a bull market for the index.

July’s flat CPI reading comes on the back of an CPI increase of 1.3% in June. For June, higher prices were meaningfully impacted by a higher cost of gasoline. In July, prices at the pump pulled back, down nearly 8%, which served as a strong contributor to the flat inflation print. In fact, many of the categories that showed an easing in their prices this past month were commodity related. In addition to gasoline prices, other categories that fell included transportation services, airfares, and utilities. All of whom are impacted by oil and gas-based commodities. On the other end, food prices remain stubbornly high, rising 1.1% in July alone, and now up 11% over the past year. In fact, the price of food at home has increased by 13.1% in the last twelve months, considerably more than food away from home, where prices are up 7.6%.

Not only was the stated CPI better than expected, but core CPI, which excludes more volatile food and energy, was a positive surprise rising only 0.3% in July. This marked a deceleration from a 0.7% increase in June. In addition, on Thursday the Producer Price Index (PPI) for the month of July was released showing a decline of -0.5%. Producer Prices are a measure of price changes in raw materials and resources used in industrial production. These often get passed on to customers after the fact. A drop in PPI is a positive indicator for the direction of prices consumers may be paying the future.

Markets have cheered an easing of inflation with the view that the Federal Reserve will not have to tighten rates as much as some have feared and they may even begin to scale back their tightening cadence in the months ahead. While this past week’s inflation report was a welcome sign that inflation can and eventually will be tamed, we don’t believe it’s prudent to claim we’ve hit peak inflation, at least not yet.

Given the nature of how these measures are calculated, there was bound to be volatility in monthly readings. June’s reading seemed artificially high and now July’s feels artificially low. In fact, this past week we saw commodity prices start to rebound. Should that continue, it will only reverse some of the past month’s gains and pressure readings into the fall. In addition, the employment report from early August showed an acceleration in wages, which tends to lead to future price hikes in order to offset the higher cost of labor.

The Federal Reserve seems steadfast in not easing up until they feel they’ve put a nail in the coffin on inflation. The more relaxed tone in both the stock and bond markets these past two months is based on the view that the Fed may ease up sooner rather than later. On Wednesday, following the favorable CPI release, two Fed governors spoke and reinforced that they believed the Fed should remain disciplined on further rate hikes to stave off inflation.

Given that it’s not yet time to claim victory on inflation, now is not the time to ramp up the risk level in portfolios to chase the rally. We don’t believe the fundamentals justify it, even if sentiment has improved and more investors are stepping in to take on risk. Valuation multiples on the S&P 500 have now risen by nearly 20% since mid-June, as prices have shot higher while earnings expectations have gone lower. We cheer the positive economic data, but it may not yet be time to waive the flag and officially declare victory over inflation.

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