10 thoughts to suggest inflation could fall more "like a rock" than a "feather." 42% of CPI components deflating off "peak" = inflation could fall faster than consensus expects.

We publish on a 3-day a week schedule:

– SKIP MONDAY due to Labor Day holiday
– SKIP TUESDAY
– Wednesday
– SKIP THURSDAY
– Friday

It was surely not a great sign that stocks:

  • sold off big Friday
  • did not manage to bounce Monday
  • did not manage to bounce on turnaround Tuesday
  • Thursday is month-end
  • Friday is the day before Labor Day weekend

Underlying the rising “despair and resignation” of investor sentiment is the view that inflation is “sticky” and will only come down gradually. And if incoming economic data is strong, this raises concern that the Fed has to do more. So, you can see the mounting despair this creates:

  • good news is bad news = Fed has to do more
  • inflation is “sticky” and therefore easy to dismiss signs of easing = bar is high
  • the JOLTS survey (job openings) posted an upside surprise for July (11.2mm vs 10.4mm Street)
  • Case-Shiller home prices rose +0.44%/ +18.65% MoM/YoY for June, pointing to continued strength in housing
  • both JOLTS and CS data are pretty stale, arguably. CS is 8 weeks old. JOLTS 6 weeks old.

10 thoughts to suggest inflation could fall more “like a rock” than a “feather”

Inflation is mysterious and uncertain. But the notion that inflation lingers and is sticky primarily stems from the epochal inflation episode of the 1970s to 80s. Even after reading Ben Bernanke’s 21st Century Monetary Policy, the factors driving that steady rise in inflation were multiple, complex and not clear that applies to 2022.

To counter the chorus inflation despair, here are some counter-perspectives:

  • consensus seems to believe inflation will only fall “like a feather”
  • but many components are “dropping like a rock”
  • 42% of CPI components are declining from recent highs = deflation
  • 25% based upon GDP weight, compared to 10-yr avg of 39%
  • meaning, getting to 2% requires 14% more components to see weakening prices
  • looking at regional CPI, 5 of the 9 US regions saw outright “deflation” in July (m/m)
  • these 5 regions represent 49% of GDP
  • in East North Central (WI, IL, MI, IN, OH), CPI annualized is -3.96%, outright DEFLATION
  • leading indicators like manheim (autos), hopper.com data (airfares), Redfin (real estate) suggest many other components of CPI could start falling outright

In other words, there are many counterpoints to suggest inflation could fall faster than consensus expects. This, in turn, would change the path of Fed policy. Arguably, the inflation swaps markets are already reflecting this, hence, the lower levels of implied inflation.

Rockets and Feathers: the adage prices move up like a rocket and fall like a feather

I have heard many economists say prices are like rockets (moving up) and feathers (falling). The title of FRED blog below is as such.

  • price increases are passed on quickly
  • but price decreases only come slowly
  • by implication, this means investors will likely expect inflation to rise fast
  • but only drift down slowly
  • hence, feathers
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.
Source: St Louis Fed (FRED) and Fundstrat

Feathers is one reason many are now diminishing signal of downside July CPI

And this idea that prices move downwards only slowly is one reason many are diminishing the downside surprise from the July CPI.

  • monthly prices fell outright in July
  • as chart below shows, this is an abrupt break in pattern
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

Many components are starting to fall like rocks… not feathers

Looking at the components of CPI, many items are beginning to fall like a rock.

10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.
Source: Fundstrat

42% of CPI components are in outright deflation from peak

Our data science team, led by tireless Ken, has put together a diffusion of the 175 CPI components. This is shown below and measures the % of components with outright declines in prices:

  • if a price is below its 18-month peak, this component is in deflation
  • even if the YoY does not yet reflect this
  • 42% of components are in outright deflation, up from a 40-year low of 34%
  • 25% on a CPI-weighted basis and the 10-yr average is 39%
  • thus, to get to “2%” avg of past decade, only 14% more of components need to “deflate”
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

Many key components are starting to fall like a rock

And the biggies that are not yet deflating are things like autos (4%), shelter (~27%) and durables (5%) and travel (2%). As we have noted previously, we see the deflation developing in many of these items below.

10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.
Source: Fundstrat

The top 50 components seeing outright deflation are below. These are sorted by “% off 18-month high”

10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

HOUSING/RENT: History shows even this component falls like a “rock”

If there is one thing I seem to hear often, it is that housing will take quite of lot of time before this component stops inflating:

  • home prices are going up due to shortages
  • fyi, Case-Shiller price data is lagged as only June was released yesterday
  • moreover, many say “rents” will go up because housing is unaffordable
  • this is partially true
  • but then many also argue “rents” are sticky and will stay elevated for awhile

We were curious whether “rent” and “owners’ equivalent rent” (OER) are truly sticky. So we gathered the data on two big metro areas:

  • NYC and SF

The BLS has CPI data for the past 40 years in these metro areas and we charted the YoY growth rate in OER:

  • when OER falls, it falls like a rock
  • both in SF and NYC areas
  • many crashes to “zero” YoY in OER took less than 12 months

The takeaway? Rents could fall a lot faster than many expect.

10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

DISINFLATION: Many regions of US starting to see disinflation

The BLS collects CPI data for 9 regions as listed below:

  • the regions have longish descriptors
  • this map helps
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

JULY CPI: 5 of 9 regions saw outright price declines

As shown below, 5 of 9 regions saw outright price declines

  • these 5 regions are 49% of GDP
  • so much of the nation saw outright price declines in July
  • with gasoline falling again in August, many will see declines in August as well
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

This map below helps visualize where CPI shakes out in July:

  • Mountain region had the highest CPI at ~5% annualized rate
  • East North Central is seeing prices fall -4% annualized
  • yup, deflation
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

STRATEGY: When markets are in “despair,” Technicals might be the truth seeker

If investors are increasingly resigned to “inflation for longer,” and thus “Fed for longer,” one can see why stocks are still weakening:

  • investors have no visibility on inflation inflection
  • how quickly inflation falls
  • and thus, when Fed can pivot
  • our base case, however, is inflation is likely falling faster than consensus expects
  • already many leading indicators are falling
  • inflation markets see inflation managed
  • consumer inflation expectations are falling and for bottom 25%-tile of answer is below average

But when markets lack visibility, then Technicals offer insights. And as noted by our Head of Technical Strategy, he sees an alignment for stocks to bottom short-term:

  • There are multiple alignments including Fibonacci, DeMark, Gann among others.
  • These are covered in his note from Tuesday evening
  • But in short, he sees high probability for a rally this week and into mid-September
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.
Source: Mark Newton, Head of Technical Strategy Fundstrat

STRATEGY: 2H rally view intact

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
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

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
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

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
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

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
10 thoughts to suggest inflation could fall more like a rock than a feather. 42% of CPI components deflating off peak = inflation could fall faster than consensus expects.

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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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