You've got to ask yourself one question
A lot is riding on a Fed pivot.
“Do I feel lucky?” Perhaps Clint Eastwood’s most famous words, in the 1971 iconic hit “Dirty Harry.’’ A lot of talk this week about peak inflation and a Fed pivot. Stocks sure seemed to view above-consensus moderation in July CPI and PPI (more below) that way. But each is still fractionally off 4-decade highs, and other key inflation measures keep trending up: wages and particularly unit labor costs (more below); shelter, the largest CPI component (it accounts for 30% of headline and 40% of core); and food. In this so-called peak inflation moment, Ford and Disney just announced big price increases for their new electric trucks and streaming services. In Manhattan, rents jumped to a record high. Median, trimmed-mean (the average after axing extremes on the distribution tails) and core sticky CPI—all measures of underlying inflation—saw substantial month-on-month increases. Yes, there are reasons to expect moderating inflation. A collapse in money supply growth. Weakening global demand. Easing supply chain pressures. Oil and foodstuffs (wheat, corn, oilseeds) moving well off peaks. A topping of inflation expectations (more below). It’s not, is inflation moderating, but how fast and to settle at what level. It’s a long way to the Fed’s 2% target, or Powell’s 2.5% neutral rate. Since the ’70s, the Fed only stopped tightening after its policy rate exceeded CPI. Looking for a Fed pivot? Do you feel lucky?
Cruise lines, airlines, memes and other high-beta, lower quality stocks were among the week’s winners as buy-the-dippers loaded with cash bid up losers. High-quality Tech is having a run, too—up +20% off mid-June’s lows, lifting the Nasdaq into a new bull market. How Tech goes, often goes the market. Citing data back to 1926, Leuthold Group says all months in which Tech outperformed, the average S&P 500 annualized price return was 27.2%, vs. -9.3% for all months when Tech underperformed. Moderating inflation is great for Tech valuations, if it holds. Do you feel lucky? JP Morgan sees short covering behind recent momentum and puts technical resistance at 4,300-4,330. Noting Treasuries have been highly correlated with equities, Fundstrat thinks the 10-year Treasury’s reversal since Wednesday’s CPI (the yield is up 17 basis points at this writing) may be a technical sign the rally is peaking. What’s the tactical move here? Piper Sandler draws parallels between the bursting of the recession-preceding Y2K bubble and the WFH bubble. Each pulled forward demand, only the latter by a factor of four, meaning a bigger (not just technical) recession may be inevitable. Technical and tactical, short the market, then buy the dip. And what’s up with the sleepy VIX?
Many say a bear-market low still lies ahead, with retail investors the missing piece. The past three major market lows occurred 1-2 quarters after substantial household investor selling. No sign of such capitulation yet. Households hold $38 trillion of equities, having bought almost $6 trillion over the past two years, with inflows every quarter since Covid, Bank of America says. What could prompt them to sell? Lower earnings? Analysts have just started cutting estimates, taking their cue from cautious Q2 forward guidance. The Fed? Even its most dovish members this week scoffed at potential rate cuts as early as next spring. Are we not supposed to fight the Fed? Last week, the “technical” guy at Evercore ISI abruptly flipped from bearish to bullish, seeing the current run taking the S&P to 4,650. He noted in the ’70s, each of three vicious bear markets gave way to stunning bull markets that reclaimed prior peaks … before making new lows. The Fed pivoted too early in those days. Whether history repeats is the question. So, you’ve gotta ask yourself one question: “Do I feel lucky?” Well, do ya, punk (Clint’s words, not mine)?
- Peak inflation is relative Year-over-year (y/y) CPI and PPI decelerated more than expected in July, with monthly headline readings unchanged for CPI and declining for the first time in two years for PPI. Services drove the slowdown—airfares plunged nearly 8% and lodging away from home (hotels/motels) fell almost 3%, retracing late-spring run-ups. But “sticky” wages and rents accelerated, and y/y headline CPI and PPI still ran at a hot 8.5% and 9.8%, respectively. PPI’s moderation—the slowest core rate since February and core goods rate since October ’20—came on pullbacks in energy, ag and materials. Import and export prices also fell, the latter for the first time in seven months and by the most since April 2020.
- A relative win Year-ahead inflation expectations fell to a 5-month low 6.2% in July on sharp declines in gas (the second-largest decline ever) and food prices (the biggest drop on record), the New York Fed said. Year-ahead rents, medical care and college bills also slipped. Separately, Michigan’s initial read of August saw inflation expectations fall a third time in four months after peaking in April, and sentiment overall improve a second straight month and more than expected off June’s record low.
- Autos bullish for manufacturing With new-car inventories a mere 84K vs. the long-term average of 1.3 million, Fundstrat sees a lot of gas in the tank for increased auto production. Supply issues have started to ease, but deep and ongoing shortages are keeping new-car prices at record highs (another inflation headwind).
- Wage-price spiral 50-year low unemployment and worker scarcity are challenging employers—in the NFIB’s July survey, small businesses said they’re still having to raise starting pay to lure workers, pushing inflation components to cyclical highs. In Q2, unit labor costs exploded 9.5% y/y, the most in 40 years. Covid stimulus—along with an aging population increasingly choosing retirement, health concerns about returning to work and parents staying home with remote-schooled children—is discouraging labor force participation, which remains below pre-pandemic levels.
- Another inflation headwind U.S. productivity just posted its weakest two-quarter performance since records began in 1947, falling at a 4.6% annualized pace in Q2 after a revised 7.4% plunge in Q1. The record drop-off obliterated a Q2-Q3 2020 surge during the Covid lockdowns.
- Housing: a cyclical bear in a secular bull Mortgage purchase applications plunged 19% y/y in the past week as record prices, higher mortgage rates and a shortage of supply are keeping potential buyers at bay. Longer-term fundamentals look promising, however. Bank of America says 67% of millennials (the nation’s largest generation) plan to buy a home in the next two years. And on their heels are Gen Z, aka “zoomers,” nearly half of whom expect to buy within the next 5 years, Rocket Mortgage said.
Somebody’s got to pay for all this Excluding intra-government obligations such as Social Security, federal debt as a percent of GDP is forecast to climb to a record 107% by 2032, surpassing World War II-era highs, and to 185% by 2052. The Congressional Budget Office sees interest costs associated with the ever-rising debt jumping from 1.6% to 7.2% of GDP by then. Federal tax revenues as a share of GDP already are at a post-war high. In the past, tax revenues of 19.3% of GDP or greater resulted in surpluses. Not this time.
BBB, Jr.? “Meh” That’s the way Wolfe Research sees it when it comes to the impact of the so-called Inflation Reduction Act on the S&P. It expects no material hit to earnings, as last-minute changes favoring depreciation further watered down 15% minimum corporate tax provisions. It also thinks the 1% excise tax on buybacks, if anything, will pull forward activity into Q4 from 2023.
These two, again?! If Trump seeks to capitalize on outrage over the raid and announce early, it’ll make November’s elections less a referendum on President Biden’s first two years (which GOP candidates would love) and more a setup for 2024, Strategas Research says, possibly clouding prospects for a Republican sweep of Congress.