The July CPI report is released today (8/10) at 8:30am ET and while we do not know if this report will be hotter than consensus, there will be some things to watch in this “hard” inflation report:
- headline CPI will fall below “core CPI” driven by falling gasoline
- headline CPI of +0.27% (per Cleveland Fed nowcast) is lowest reading in all of 2022
- leading indicators of inflation, such as gasoline, travel-data, commodities, suggest “hard” data is way above real-time inflation
- July gasoline likely subtracted -38 bps in July CPI
- August gasoline could subtract -81 bps in August or 2.5X impact
- gasoline could fall to $3.54 by end of August
So, even if there is an ugly July CPI figure, we think any sell-off will be short-lived. Recall, there are many warning some components of CPI remain elevated:
- used cars/new cars (see discussion below)
- shelter/rent is still rising
- higher energy still working its way through pass-on pricing
Gasoline to subtract -38 bps from headline CPI in July…
CPI month-over-month is cooling because a big swing in gasoline as mentioned above. Gasoline prices have not yet caught up to the fall in gasoline futures because of the predictable lags.
- in late June, our data science team forecasted the path of July gasoline (see scenario 2)
- the actual path was identical to this forecast
- this will subtract 38bp from CPI in July (month-over-month)
- aka deflation impact
$3.54 gasoline? Gasoline deflation impact on August CPI could rise to as high as 81bp, or 2.5X greater
Analysis from our data science team, led by tireless Ken, shows that gasoline could fall further in August:
- they forecast $3.54 gasoline by the end of the month
- currently $4.03 (AAA gasoline)
- this will subtract -71 bps from headline CPI in August. But if gasoline price falls further (to the start of the year level), -81 bps could be subtracted from headline CPI
- this drop in gasoline not yet reflected in Cleveland Fed inflation forecast
The takeaway is CPI could be further decelerating in August. Thus, we expect markets to be sanguine post-July CPI.
USED CARS: Declining sequentially, but gonna show acceleration YoY
Used car prices are still easing month-over-month given the latest data from Manheim:
- but the YoY is actually ticking up to +12.5%
- this is because in 2021, used car prices fell month-over-month in summer, contrary to seasonals
The seasonal pattern of used car prices is shown below. And as we can see:
- in 2021, used car prices fell, while not doing this in 2020 nor 2019
- thus, YoY is showing an acceleration due to year-ago factors
- this is why the month-over-month CPI is arguably more important
But there remains a shortage of cars for sale. The New Car inventory today stands at a mere 84k.
- this is way below the long-term average of 1.3 million
- supply chains and auto production are recovering
- but there is still an inventory build needed
…auto inventory is modestly better than a few months ago
Auto production has improved so that there is a modest increase in inventories in 2022.
- this figure was a mere 65,000 in February
- so 84,000 is an improvement
- but hardly near the 500k-1 million seen pre-pandemic
STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull
Those who followed my work during my JPMorgan days might recall we published a report called the “Guide to Stock Bottoms: Part I.” And one of the notions we discussed is bear markets are mere retracements of the prior advance. Thus, a bear market is unwinding the prior gains.
The 2022 decline is different, as this sell-off is a reaction to aggressive and targeted Fed action. This is a tightening cycle which has attempted to quell demand by forcing risk assets lower. Thus, we do not think the context of a recession-driven bear market dynamic is as applicable.
- but the duration of this bear market relative to the prior bull market is applicable
- as this was a short bull market and thus, makes sense should be a short bear market
Bear markets are 21% of the prior bull market
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
BOTTOM LINE: If equities sell-off after the July CPI, buying the dip makes sense
Our head of Technical Strategy, Mark Newton, sees higher odds of a pullback into August. There are multiple signs he is watching and are discussed in his notes. In short:
- he sees chances for S&P 500 to fall back towards 3,900 into August
- but this is a buyable pullback
TECHNICALS: S&P 500 could pull back to 3,900 = buying opportunity
Frankly, a pullback would be welcome, given stocks moved up so sharply in the past few weeks. And our clients remain mostly skeptical. In our conversations, most cite the fundamental risks:
- inflation is still high
- recession is still coming
- EPS downgrades coming
- too short to be a proper bear
- Fed still hiking
While many cite this, look at how well stocks are reacting to incoming news. The negative pre-announcements and lowered guidance by semiconductors.
- if these negative announcements happened in May/June, equities would have gone into a death spiral
- today, stocks are down but not that materially
- arguably, this shows how light positioning is within equities
- if investors are bracing for the worst, bad news itself has less impact
- argues to “buy the dip”
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