The August CPI Report May Set Up Another Big Bear Trap (SP500)

It has been a superb yr for inventory market traders with the S&P 500 (SP500) returning greater than 17% so far and almost 30% greater from the 2022 lows. The mixture of a resilient financial system, easing inflation, and powerful company earnings shocked quite a lot of very good individuals from this time final yr. We have been bullish throughout this run and may 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 incorrect 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 a giant market correction did not pan out.

We deliver this up as a result of now we have one other certainly one of 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 yr 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 charge 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

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

The final reported July inflation charge at 3.2% is an evening and day distinction in comparison with situations on the cycle peak final yr when the CPI hit 9.1%. The headline charge has benefited from sharply decrease power 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 charge

• For the August CPI, the present consensus is for a tick greater within the headline annual charge 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 power 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 now not a “drawback” 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 under expectations.

Naturally, we count on market bears to run circles round this determine as proof Fed is dropping 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 Improvement:

• 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 power, is extra favorable as a result of elements on that aspect of the buyer worth basket have been seen as “sticky” or stubbornly excessive all yr and are lastly making an even bigger transfer decrease.

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

Falling Shelter Costs But To be Captured in BLS Information

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 in opposition to the official Bureau of Labor Statistics (BLS) CPI information. Whereas many indicators recommend house costs and rents have peaked, BLS has lagged based mostly on its measurement intervals and survey assortment methodology.

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

Trade information 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 development, with a climbing quantity suggesting extra draw back for the index stage going ahead.

Affordability is low, shopper spending is pressured, which suggests 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.

By way of house gross sales, the developments are additionally encouraging with worth development turning flat based on the S&P CoreLogic Case-Shiller Index in June and even barely unfavourable on an annual foundation with information from Realtor.com.

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

That is additionally the case within the used automobile market, the place we wish 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 yr. This index is nice as a result of it tracks tens of millions of listings consumers 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 influence of excessive mortgage charges and shoppers already underneath stress, car costs inside the CPI are one space now we have an additional 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) at the moment round $87/bbl, up from as little as $67/bbl in June. Naturally, a few of that ought to be captured within the power part 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 developments, and we’re not there but. The present nationwide common for the value of gasoline at $3.80, is nicely under the height in 2022 when ran above $5.00 a gallon.

Situations final yr that took the value of oil briefly above $130/bbl had been distinctive as they had been pushed by world provide chain disruptions and even the preliminary uncertainty of the Russia-Ukraine struggle. We’re simply not seeing the availability crunch vital 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 when it comes to 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 facets of inflation it may management with core indicators taking priority at this stage within the cycle.

What concerning the Fed?

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

Then again, the query turns into extra attention-grabbing looking to the top of the yr, the place the market is sort of cut up on the place the Fed Funds charge shall be set on the December assembly.

In accordance with the present market implied chances based mostly on Fed Funds charge futures, there’s a 53% likelihood the Fed will maintain on the present charge by year-end, in comparison with a forty five% likelihood of a hike. We’re within the maintain camp.

The decision now we have is that the Fed is completed, and additional hikes are pointless for the CPI to proceed trending decrease. The Fed has stated it’s data-dependent, and the excellent news right here is that the info 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 financial system as now we have seen all yr.

The best way to see it enjoying out is that better market confidence that the Fed is completed climbing as a result of the CPI is trending decrease by the top of the yr, 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 danger sentiment. As a aspect be aware, we see worth in long-term bonds general.

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 danger to contemplate.

By this measure, market bears are type 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 year-end.

• Easing inflation by a falling core CPI.
• Stability in charges because the FED stays on maintain, with room for charge cuts in 2024.
• Resilient financial indicators between a secure labor market and modest financial development, 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 yr.

Ultimate Ideas

We talked about the bear lure initially of the article. On this case, anybody anticipating a giant selloff simply because the annual headline CPI charge ticks greater within the August report could discover themselves disenchanted. We count on the developments 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 stated a number of instances they’re data-dependent, and that is excellent news for the inventory market because it pertains to the indications that matter. With among the main U.S. fairness indexes off a couple of proportion factors from their highs, the decision right here is to purchase the dip into the August CPI report.