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Inflation Continues

Mark DiOrio, CFA

US equities declined this week as inflation numbers contribute to a challenging macro backdrop for financial assets. As mentioned at the end of last week’s blog, the market would be watching the release of the latest Consumer Price Index (CPI) and Producer Price Index (PPI) inflation numbers. The CPI rose to 8.5% year-over-year, the fastest annual rate since 1981. Produce Price Index inflation numbers were even steeper at just over 11% year-over-year, also multi-decade highs.

The 10-Year treasury yield, which is a major market data point that investors use, rose to multi-year highs by the end of the week, just over 2.80%. It was the highest level since late 2018, during the last Federal Reserve rate tightening cycle. During the fourth quarter of 2018, the 10-Year Treasury Yield traded mostly above 3%, peaking around 3.25%.

The good news continues to be on the labor front. For years, a challenge has been low wage inflation. That is no longer the case. According to data compiled by the Atlanta Federal Reserve’s Wage Growth Tracker, the year-over-year wage inflation clocked in at 6%, the highest pace in three decades. The data breaks it down into job switchers (+7.1%) and job stayers (+5.3%). While this is below current inflation readings, it is showing that inflation is flowing down to labor.

Chart of the Week

Market Update

Equities

Broad market equity indices finished mixed on the week with blue chips and small caps higher and traditional growth stocks continuing to have trouble dealing with a rising interest rate environment. Tech stocks have been sensitive to rising interest rates.

S&P sectors varied wildly this week. A similar theme with energy having a strong week joined this week by materials. These are inflation beneficiary stocks reflecting investors desire to find areas benefitting from inflation. Energy holds a clear lead YTD, but zooming out to an investor’s time horizon, energy is also the worst performing sector over the last 5 and 10 years.

Last week ending 4/14/2022

YTD through 4/14/2022

Commodities

Oil reversed its recent weakness and moved higher on the week, closing back above $100/barrel. Prices may be resilient given the uncertainty around geopolitical events.

Gold rose this week even as the U.S. dollar strengthened. Gold is a common “safe haven” asset, typically rising during times of market stress. Focus for gold has shifted again to include not just global macroeconomics surrounding COVID-19 damage and recovery efforts, but also inflation. A new source of volatility will continue to be the conflict in Ukraine, as conflict may push investors into safe havens.

Bonds

Yields on 10-year Treasuries rose this week from 2.72% to 2.82%, while traditional bond indices fell sharply. Expected increases in future inflation risk have helped elevate yields since pandemic era lows in rates. Treasury yields will continue to be a focus as analysts watch for signs of changing market conditions.

There are a number of challenges for traditional fixed income assets, but much of it may be priced into the market. The bond market has moved extremely fast in anticipation of future Federal Reserve interest rate moves.

Lesson to be Learned

The Consumer Price Index is considered the benchmark measure of inflation. When price-level comparisons are made, on both a historical and an international basis, the consumer price index is almost always the chosen index. The CPI is also the price index to which so many private and public contracts, as well as social security and government tax brackets are linked.

– Jeremy Siegel, Ph.D., “Stocks for the Long-Run” 5th Edition

Legacy Indicators

Two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).

Briefly, we want the RPI to be low on a scale of 1 to 100.  For the US Equity Bull/Bear indicator, we want it to read at least 66.67% bullish. When those two things occur, our research shows market performance is typically stronger, with less volatility.

The Recession Probability Index (RPI) has a current reading of 31.05, forecasting a lower potential for an economic contraction (warning of recession risk). The Bull/Bear indicator is currently 33% bullish, meaning the indicator shows there is a slightly lower than average likelihood of stock market increases in the near term (within the next 18 months).

It can be easy to become distracted from our long-term goals and chase returns when markets are volatile and uncertain. It is because of the allure of these distractions that having a plan and remaining disciplined is mission critical for long term success. Focusing on the long run can help minimize the negative impact emotions can have on your portfolio and increase your chances for success over time.

The Week Ahead

This week will see updates to Housing starts and existing home sales, along with initial jobless claims.

More to come soon. Stay tuned.

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