The most important event this week, in our view, will be August CPI (9/13). Hopefully (we expect) this will show that inflation in the US indeed peaked in June 2022:
- consensus looking for -0.1% MoM (or -1.2% annualized) and core +0.3% (+3.6% annualized)
- the unknown remains the pace at which inflation will decline
- consensus and even Fed generally view this as “gradual” and thus, expect policy to remain tight for longer
- but as our analysis has shown, inflation, once it peak, tends to “fall like a rock”
- thus, the upside surprise, if there were to be one, is that August CPI shows larger weakening in inflation
Stocks have shown resilience in the past week, and part of this is attributable (in our view) to the market’s recognition that inflationary pressures are cooling. In fact, we have 5 observations heading into this August CPI print (9/13), which hopefully provides context to the report:
- 42% of CPI basket already “deflating” from peak, but there is a lag before it shows up in YoY declines
- 5 of 9 regions of the US saw outright “deflation” in July CPI (month-over-month)
- Many CPI components that had strong inflation early in 2022 are cooling = transitory
- Rent increases are slowing
- JPMorgan economists posit that 1Q and 2Q GDP will ultimately be revised higher = further dispelling “we are in recession” arguments
In short, we believe the underlying dynamics support the notion that inflation in the US has peaked. There may be some who counter this arguing: inflationary trends are stronger than they appear. But as we have highlighted many times, the leading indicators argue otherwise.
In July, 42% of CPI was in outright deflation
Recall, a few weeks ago, our data science team, led by tireless Ken, produced this chart. This shows the % of CPI components that have outright “deflated” from their peak:
- this figure has risen to 42%
- and up from a multi-decade low of 34% in early 2022
- this is 25% of the weighted CPI basket and needs to get to 39% to be at “long-term average”
In other words, the diffusion of items suggests that inflationary pressures could ease faster than many expect.
And July CPI had shown 5 of 9 regions of the US were in “deflation” in July
Regionally, 5 of the 9 regions in the US are seeing outright price declines in July. This is shown below and in fact, the declines were substantial in the Midwest:
- in the Midwest (“East North Central”), prices are falling at nearly 4% annualized rate = deflation
Many formerly “sticky” CPI items are tanking
The August CPI report should also show that many “sticky” CPI components are not as sticky as initially believed. The comments from Michael Feroli, Chief US Economist at JPMorgan, highlight this.
Used cars are an example of how CPI YoY is not necessarily the most real-time and even appropriate way to see inflationary trends:
- used car prices, per Manheim, peaked in Jan 2022 and down 7 consecutive months
- yet, YoY CPI shows used vehicle prices up +8% YoY
- the 6-month trend is falling like a rock with -8.9% or nearly -18% annualized
So, are used car prices rising or deflating? To me, they are clearly deflating.
The tweet shared by @carlquintanilla highlights the anecdotes suggesting used car prices could even fall further “off the cliff”
Rents are sticky, but the pace of gains slowing sharply
Rents are sticky and are the last component (and sizable) still rising. But market-based measures show considerable cooling:
- the tweet by @MFHoz shows Apartment List market rents slowing sharply
- there is some seasonality as well
- but the trends in 2022 look to be far weaker than 2021
Finally, 1H2022 GDP could be revised up
There are many who believe the US is already in recession. In fact:
- many business surveys show this concern as well
- and many investors cite 1Q and 2Q showing negative GDP as an argument why the US is in recession
But the comment from Michael Feroli caught my eye. He notes that subsequent statistical revisions likely show the US grew in 1H2022 in GDP terms:
- in other words, if GDP growth was positive in 1Q2022 and 2Q2022
- how does one argue the US is in recession?
- it makes the 27% equity drawdown seem excessive
STRATEGY: 2H rally view intact
Given the list of market worries above, the natural question is how is there a positive thesis on equities into 2H2022? Here is our take:
- our continuing analysis shows leading indicators point to disinflationary/deflation
- US corporates remain impressively resilient, enduring the pandemic global shutdown with cost discipline
- and US corporates are weathering the inflation surge impressively as well
- the US economy has managed to absorb rapid Fed rate hikes so far
- and US economic relative positioning far stronger in 2022
- US net beneficiary of higher energy prices, absolute and relative (US exports oil)
- US is on-shoring assets = future competitive advantage
- US has labor issues, but this will be solved by either automation or rise in workforce participation
- investor sentiment is rock bottom and worse than GFC by some metrics
- fixed income markets show far less inflation in swaps, etc
- and while many believe “bonds are getting it wrong” including Fed officials
- the drop in energy and housing and other indicators are supportive of this lower inflation outlook
- hence, Fed could do far less tightening as the market is doing Fed’s work
Bottom line. We see 2H rally thesis intact.
STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull
Our data science team put together the comparative duration of bull markets and bear markets, and the corresponding ratio:
- since 1942, there have been 14 such cycles
- median ratio of bear vs bull is 31%, meaning a bear market is roughly 1/3 duration
- since 1982, this ratio is only 15%
- in 2022, the preceding bull market was 651 days
- the current bear market was 164 (using 6/16)
- or 25% ratio
As seen below, this ratio is solidly within the ranges seen since 1982.
- many investors think “more time” is needed for this bear market
- but given the shortness of the preceding bull market 651 days versus 1,309 median
- the corresponding bear market should also be shorter
BUY THE DIP REGIME: Stocks already saw fundamental capitulation
And we want to revisit the chart below, which looks at the internals of the S&P 500 — the % stocks >20% off their highs, aka % stocks in a bear market.
- this figure surged to 73% on 6/17
- this was only exceeded 3 times in the past 30 years
- each of the 3 prior instances was the market bottom
- we think this is the 4th instance
BUY THE DIP: forward returns strong
And stocks have the best forward returns when this figure exceeds 54% as shown below:
- in 3M, 6M and 12M
- the best decile for returns
- is when this figure is oversold >54%
- hence, buy the dip regime is in force
We publish on a 3-day a week schedule:
Monday
SKIP TUESDAY
Wednesday
SKIP THURSDAY
Friday
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33 Granny Shot Ideas: We performed our quarterly rebalance on 7/12. Full stock list here –> Click here
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