The latest consumer price index caused a collective sigh across Wall Street this week. Inflation has peaked, sang many economists, strategists and headlines. But the logic behind the optimism is flawed.
Consider first the inflation report that followed the CPI. The producer price index is often overshot because what matters most to the economy is what happens with consumers, who make up two-thirds of gross domestic product and whose expectations of future prices help determine real inflation. But investors should take the March PPI, which rose a record 11.2% from a year earlier, even more seriously than the corresponding CPI.
Before the pandemic, the PPI didn’t do a great job of predicting the CPI, says
economist Veronica Clark. “But when we get big changes, like over the past year, it’s a more reliable leading indicator,” she says.
And the details of the PPI are striking. For wholesalers, the price of vegetables increased by 82% last month compared to the previous year. Grain prices have increased by 40% while the meat and fish categories have increased by an average of 23% compared to March 2021. Then there is energy. Heating oil, diesel and gasoline increased by 106%, 64% and 60% respectively.
These are, of course, the very categories that central bankers eliminate to arrive at the “core” inflation measures that guide policy. Therein lies the reason why the peak inflation argument seems as dishonest as it is flawed. It is based on a lower than expected rise in core inflation, which in normal times means core inflation and is not controversial.
But now already high food and energy prices are rising as war in Ukraine rages on, threatening global food and energy supplies given the amount of fertilizer, oil and crops from the region. Food and energy are increasingly hogging business and household incomes, worsening confidence and raising inflation expectations.
Consider the recent report from the National Federation of Independent Businesses. A third of small business owners now call inflation their biggest problem, up from around a quarter of owners in February. A net 72% of owners raised average selling prices last month, the highest reading in the survey’s 48-year history. Meanwhile, a New York Fed report showed consumer one-year inflation expectations jumped, hitting a record high of 6.6% in March. This does not look like an inflation spike.
An indication of how households and businesses are actually feeling is a metric compiled by John Williams, an economist who runs the Shadow Government Statistics website. It uses the CPI methodology that the government used in the 1980s, before changing the way it treats housing and introducing concepts like substitution. The official CPI no longer measures the cost of maintaining a constant standard of living, Williams says. Its index, which it says reflects the cost of maintaining a standard of living, rose 17.2% from a year earlier, the fastest since 1947. That’s what Barron’s Basics measures from this column, averaging price changes on essentials like meat, milk and gas, increased 19% from the previous year.
There are reasons beyond food and energy to doubt the peak inflation argument. On the one hand, says Citi’s Clark, while simple math could put inflation numbers on a plateau, investors should brace for another push in a few months given the upside risks to commodity prices. raw materials.
So take shelter, which is a third of the CPI. The component rose 5% in March from a year earlier, faster than in February. Richard Farr, chief market strategist at Merion Capital Group, calls shelter the “true delta” to underlying inflation and says the cost of shelter will rise. He notes that the Federal Reserve Bank of Dallas sees rent inflation accelerating to a 6.9% year-over-year clip by December 2023 — an estimate Farr says is low. House prices have continued to rise since the survey was conducted, with rents lagging house prices by about a year, not to mention upward pressure from the lifting of eviction moratoria. in the event of a pandemic, he says.
There’s an overlooked technical factor at play, too. The government said it would change the way it measures new vehicle prices in April, swapping its current series for an experimental index using data from analytics firm JD. Power. The experimental index has significantly outpaced the published new-vehicle index, which is 4% of the total CPI, meaning the change should boost consumer inflation figures from this month.
What does all this mean for the stock market? So far, corporate margins have held up, even hitting record highs in the fourth quarter, says Nancy Tengler, CEO and chief investment officer at Laffer Tengler Investments. “But the pricing power is not infinite,” she says. Tengler expects the impact of soaring producer prices to start showing in the second-quarter and full-year guidance as executives drop hints of price resistance and margin pressure. as the first quarter earnings season unfolds.
“I think sticky, persistent inflation will be with us for a long time,” Tengler says, noting that the Atlanta Fed’s “sticky” CPI — a weighted basket of items that change prices relatively slowly — has been climbing. 4.7% in March compared to the previous year. . It has positioned itself for continued inflation and slowing growth, favoring areas such as materials, energy and real estate investment trusts.
The spike inflation narrative is popular, for obvious reasons, and it is no different from the old argument about transient inflation. But investors shouldn’t buy it, at least not yet.
Write to Lisa Beilfuss at [email protected]