The August CPI Report Might Set Up One other Massive Bear Lure (SP500)

It has been a superb 12 months for inventory market traders with the S&P 500 (SP500) returning greater than 17% to this point and practically 30% greater from the 2022 lows. The mixture of a resilient economic system, easing inflation, and powerful company earnings stunned loads of very sensible folks from this time final 12 months. We have been bullish throughout this run and might make the case that there’s extra upside forward.

On the similar time, it is the perma-bears which were caught flat-footed on the unsuitable aspect of the narrative. We will look again at a number of “bear traps” in latest months, the place the market was capable of climb over the proverbial wall of fear in 2023. Speaking factors that appeared to sign the beginning of an enormous market correction did not pan out.

We deliver this up as a result of we now have one other one among these massive moments developing. The August CPI report, set to be launched on September thirteenth, will assist set the market tone out there for the remainder of the 12 months with implications for the subsequent steps in Fed coverage.

Our name is {that a} favorable inflation studying, significantly on the core aspect, ought to be sufficient to maintain the Consumed maintain and shut the door on additional fee hikes. The setup right here is for shares to regain momentum from the latest dip and finally reclaim the latest highs.

August 2023 CPI Report Preview

After we speak concerning the “gentle touchdown” within the economic system, our interpretation of that’s the Fed’s capability to deliver down the CPI towards the two.0% goal, with out wrecking the economic system. What we have seen is that following a string of 11 fee hikes since early 2022 taking the Fed funds fee from zero to five.5%, is that the technique is working.

The final reported July inflation fee at 3.2% is an evening and day distinction in comparison with circumstances on the cycle peak final 12 months when the CPI hit 9.1%. The headline fee has benefited from sharply decrease vitality costs over the interval whereas pressures from different classes like meals have additionally settled. We must always get extra proof of that with this replace.

Ignore the uptick within the August headline CPI annual fee

• For the August CPI, the present consensus is for a tick greater within the headline annual fee to three.6%, in comparison with 3.2% in July.

Our take right here is that this ought to be interpreted as month-to-month variability and never indicative of an actual change in pattern. A latest rebound in vitality off the lows is a part of that dynamic, however not essentially regarding proper now.

It is clear to us that even with a CPI of three.6%, inflation is not a “downside” and the Fed has already executed sufficient. There may be nonetheless a path right here for the CPI to stabilize decrease into 2024. There may be additionally the chance this determine is available in beneath expectations.

Naturally, we anticipate market bears to run circles round this determine as proof Fed is shedding management and might want to proceed climbing, however that will be a mistake because it misses the larger image.

Drop in Core-CPI is the Bullish Growth:

• From 4.7% in July, the present market estimate is for the core CPI in August to fall to 4.3%.

Right here the setup with the core-CPI, which excludes meals and vitality, is extra favorable as a result of parts on that aspect of the buyer worth basket have been seen as “sticky” or stubbornly excessive all 12 months and are lastly making an even bigger transfer decrease.

We anticipate a optimistic market response to the core CPI reaching its lowest stage since 2021 since that is the pattern the Fed will probably be paying extra consideration to, particularly at this stage within the cycle. The transmission of the tightening executed over the previous 12 months is ongoing.

Falling Shelter Costs But To be Captured in BLS Knowledge

The explanation we’re assured that core will proceed to pattern decrease is by observing an obvious divergence between non-public market “real-time” benchmarks towards the official Bureau of Labor Statistics (BLS) CPI knowledge. Whereas many indicators recommend residence costs and rents have peaked, BLS has lagged primarily based on its measurement intervals and survey assortment methodology.

As that converges decrease going ahead, some of the cussed and elevated parts of the CPI shelter which climbed by 7.7% in July ought to appropriate and drag decrease your complete index. This might additionally assist stability any volatility in vitality costs.

Trade knowledge from “Apartment List” reveals that the nationwide hire index in August contracted for the primary time since 2020, falling by -1.2% y/y. The identical report additionally reveals that 72 of the highest 100 main cities within the U.S. are presenting unfavourable year-over-year hire progress, with a climbing quantity suggesting extra draw back for the index stage going ahead.

Affordability is low, client spending is pressured, which implies there is not a lot of a cause to see why rents and different core classes’ costs are all of a sudden going to reverse greater.

When it comes to residence gross sales, the tendencies are additionally encouraging with worth progress turning flat in accordance with the S&P CoreLogic Case-Shiller Index in June and even barely unfavourable on an annual foundation with knowledge from Realtor.com.

Once more, these drops are in sharp distinction with the 7.7% enhance in shelter costs seen within the July CPI knowledge. We anticipate the August report to start higher reflecting these present market circumstances.

That is additionally the case within the used automobile market, the place we prefer to comply with the “CarGurus Index” which reveals the common worth of used vehicles is down by -0.8% just over the last 30 days, and -7% over the previous 12 months. This index is nice as a result of it tracks tens of millions of listings patrons are seeing proper now.

That is one phase that continues to be skewed going again to pandemic provide shortages and manufacturing stoppages. As new automobile inventories construct, mixed with the affect of excessive mortgage charges and customers already beneath stress, automobile costs inside the CPI are one space we now have an extra draw back.

Oil Value Rally Not But Regarding

What has raised some eyebrows is the continuing rally within the worth of oil, with WTI crude (USO) presently round $87/bbl, up from as little as $67/bbl in June. Naturally, a few of that ought to be captured within the vitality element of the CPI for August, even because the annual pattern stays unfavourable.

In our view, oil solely turns into a trigger for concern above ~$100/bbl as a stage that would kickstart a brand new spherical of cost-pull inflationary tendencies, and we’re not there but. The present nationwide common for the worth of gasoline at $3.80, is nicely beneath the height in 2022 when ran above $5.00 a gallon.

Circumstances final 12 months that took the worth of oil briefly above $130/bbl had been distinctive as they had been pushed by international provide chain disruptions and even the preliminary uncertainty of the Russia-Ukraine battle. We’re simply not seeing the availability crunch mandatory for oil or gasoline to make that sort proper now.

So whereas oil can nonetheless rally a bit greater from right here, it is not fairly a game-changer by way of its implications for the CPI, particularly this upcoming August report. The best way we see it’s that the Fed is extra involved concerning the elements of inflation it may well management with core indicators taking priority at this stage within the cycle.

What concerning the Fed?

Outdoors of a spectacular shock greater to the CPI knowledge coming in scorching, the overwhelming consensus is that the Fed will preserve charges regular on the subsequent FOMC set for September twentieth. The latest August payrolls report confirmed an uptick within the unemployment fee together with messaging from Fed officers suggesting they’re content material to attend it out and soak up a couple of extra months of knowledge.

However, the query turns into extra fascinating searching to the top of the 12 months, the place the market is sort of cut up on the place the Fed Funds fee will probably be set on the December assembly.

In response to the present market implied possibilities primarily based on Fed Funds fee futures, there’s a 53% likelihood the Fed will maintain on the present fee by way of year-end, in comparison with a forty five% likelihood of a hike. We’re within the maintain camp.

The decision we now have is that the Fed is finished, and additional hikes are pointless for the CPI to proceed trending decrease. The Fed has mentioned it’s data-dependent, and the excellent news right here is that the information on the inflation aspect has turned out nicely. This situation ought to be optimistic for the inventory market, particularly whether it is accompanied by continued resiliency within the economic system as we now have seen all 12 months.

The best way to see it taking part in out is that higher market confidence that the Fed is finished climbing as a result of the CPI is trending decrease by way of the top of the 12 months, ought to work to push market charges and bond yields decrease.

Wanting on the 10-year Treasury as a benchmark, room for the yield to drag again in the direction of 3.75% as our year-end goal would additionally enable the U.S. Greenback to weaken as a backdrop of extra optimistic threat sentiment. As a aspect word, we see worth in long-term bonds total.

The opposite aspect to the dialogue is the bearish case, the place the inflationary outlook deteriorates and inflation expectations climb greater for any variety of causes. This might pressure the Fed to renew climbing and switch extra hawkish, creating a brand new spherical of volatility in bonds and shares as the important thing threat to contemplate.

By this measure, market bears are form of betting on the CPI and core-CPI to return in hotter than anticipated, as a catalyst for the market to reset expectations decrease.

What about Shares?

We stay bullish on shares and see the next components as driving additional upside by way of year-end.

• Easing inflation by way of a falling core CPI.
• Stability in charges because the FED stays on maintain, with room for fee cuts in 2024.
• Resilient financial indicators between a secure labor market and modest financial progress, brushing apart fears of a recession.
• Continued company earnings momentum stepping into the Q3 reporting season subsequent month.
• Revisions are greater to earnings estimates into subsequent 12 months.

Closing Ideas

We talked about the bear lure initially of the article. On this case, anybody anticipating an enormous selloff simply because the annual headline CPI fee ticks greater within the August report might discover themselves disillusioned. We anticipate the tendencies within the core CPI to steal the present, which ought to be sufficient to maintain the Fed from climbing on the subsequent FOMC as a extra bullish improvement.

The Fed has mentioned a number of occasions they’re data-dependent, and that is excellent news for the inventory market because it pertains to the indications that matter. With a number of the main U.S. fairness indexes off a couple of share factors from their highs, the decision right here is to purchase the dip into the August CPI report.