Wentz Weekly: Inflation Cools, Market Momentum Continues, But Pay Attention to the Details

Wentz Weekly Insights
Inflation Cools, Market Momentum Continues, But Pay Attention to the Details

After multiple months of inflation surprising to the upside, investors finally got a bit of welcoming news with inflation coming in lower than expected based on the most recent data from the July consumer price index. Markets celebrated the report, sending stocks higher and bond yields lower, while market’s odds of a more aggressive 75 basis point interest rate increase at the Fed’s next meeting September 16th moved to around 25% from closer to 75% before the inflation data was released.

Although it was a step in the right direction, we have to remind ourselves inflation is still at 40-year highs, rising 8.5% from a year ago. This decelerated from the year-over-year peak of 9.1% that occurred in June, but the decline was purely due to a drop in prices in one category – energy. In July the consumer price index, a monthly report that measures the average change over time in prices paid on a basket of goods and services, was unchanged compared to June. However, excluding the volatile energy category, the index was up 0.3% in July, still welcoming as it decelerated from the average 0.6% monthly rate over the previous three months.

In July, energy prices fell 4.6% and that was driven by a 7.7% decline in gasoline prices. In fact, last week AAA said the average price for a gallon of gas fell below $4/gallon for the first time since March, alleviating consumers’ cost at the gas pump, but still much higher than $3.29/gallon where it started the year.

Other categories continue to show strong price pressures, including categories that affect everyone from food to shelter. Food prices were up another 1.1% in the month and have averaged a 1.0% increase each month since the beginning of the year, with consumers paying 11% more on food on average compared to 12 months ago. The largest category in the index, shelter, increased 0.5% due to the rise in home prices and rents. Changes in home prices typically take 12-24 months to reflect in the CPI, indicating there are many months ahead of strong price gains in the shelter category. Shelter prices are known as being “sticky” meaning they are longer lasting and harder to bring down than other categories such as prices of goods and commodities, and in recent months are showing increasing inflationary pressure, and is similar to late cycle where prices remain stubbornly high.

At the end of the day, the report was encouraging but the details of the report show there is still much more work left to do. This will keep the Fed on path with one of its most aggressive rate hiking cycles since inflation was last at double digit levels in the early 1980s (which will be further supported by the strong labor market). Fed officials have indicated their intention of getting the federal funds rate to 3.5% by the end of the year and compared to the current rate of 2.25% suggests another 1.25% worth of rate increases over the remaining three meetings of 2022. In 2023, the projections show another 50 bps worth of increases (to a final/terminal rate of 4.0%). While it was good news and pulled market expectations of rate increases slightly lower, there will be many Fed officials speaking this week. We expect the message will be to remind markets the Fed will maintain its path of rate hikes in effort to continue bringing inflation lower which may be the news that pauses or stops the recent market rally.

Week in Review:

Global Momentum continued as the week opened last Monday, particularly with growth stocks which led the way higher again. The day was a flashback from a little over a year ago when the meme trade made headlines along with the most heavily shorted stocks, as those names surged on Monday. It was enough to push to NASDAQ briefly into a bull market (a 20% gain in just 35 days from the bottom in June). Gaining a bit of attention and possibly helping fuel the trade was the New York Fed survey of inflation expectations that showed consumers expectations on one year and three year ahead inflation moved notably lower. However, stocks moved lower in afternoon trading with the NASDAQ falling slightly into the red, closing 0.1% lower, while the S&P 500 fell 0.12%. Small caps stood out with the Russell 2000 1.01% higher on the day. The other big headline on the day was Senate Democrats passing the $700 billion package on climate, healthcare, and taxes that is being referred to as the Inflation Reduction Act.

Several company specific headlines had markets opening very mixed Tuesday. There were a couple M&A headlines including Signet Jewelers acquiring e-commerce Jeweler Blue Nile, and software company AppLovin making a bid to acquire Unity Software. However, most the headlines were from the semiconductor sector after Nvidia’s warning on Monday and memory chip maker Micron saying Tuesday its revenues would come in below the low range of its previous forecast after seeing demand slow as customers adjust inventories. It was a reversal from the past several days, with value outperforming growth and volume favoring the downside. The S&P 500 declined 0.42% with the NASDAQ down 1.19%.

All eyes were on the July inflation report Wednesday morning which showed inflation may have peaked in June with July prices flat sequentially and decelerating year-over-year to 8.5%. Investors cheered the report, sending bond yields lower, particularly on the short-end of the yield curve which caused a steepening of the curve and a rally in the markets, specifically higher growth stocks that have been hit the most year-to-date. Several Fed members made remarks after the report, sticking with their intentions on raising rates with the target unchanged, and despite this the market’s expectation on a 75 basis point increase move lower while the expectation of a 50 basis point increase moved higher.
Stocks rallied through the day ending near the highs of the day with strong internals and the NASDAQ leading the way closing 2.89% higher while the S&P 500 gained 2.13%.

The producer price index Thursday morning surprised to the downside as well, helping markets continue the momentum into the day. In addition, San Francisco Fed’s Daly said she supports a slower rate hike, but it is too early to declare victory on inflation. Stocks were not able to hold onto the early gains though and finished mixed with the NASDAQ finishing down 0.58% and the S&P 500 down 0.07%.

Friday was a more quiet day with markets continuing to trade higher. The preliminary University of Michigan consumer sentiment survey exceeded expectations with one-year ahead inflation coming in softer while five-year inflation ticked up slightly, but despite the lower inflation expectations Fed officials reiterated rates will need to rise to a restrictive level until there is a sustained period of lower inflation. Stocks had another solid day with the S&P 500 closing 1.73% higher.

For the week, Treasury yields moved lower after the inflation report mid-week but moved higher into the end of the week and ended relatively unchanged with the 2-year and 10-year spread remaining around -40 basis points. Oil recovered some of its recent decline, rising 3.5% for the week while stocks were lower three days of the week but still managed to finish much higher for the fourth consecutive week with the stretch being the best four-week stretch in almost two years. The major U.S. stock indices finishing as follows: Russell 2000 +4.93%, S&P 500 +3.26%, NASDAQ +3.08%, and Dow +2.92%.

Recent Economic Data

• U.S. worker productivity decreased 4.6% in the second quarter of this year (all numbers on an annualized rate), about the same decline that was expected, but this follows a 7.4% decline in productivity in the first quarter. Productivity measures how efficiently the U.S. converts inputs into outputs of goods and services and is one of the most important factors that drives long-term economic growth. The 4.6% decline was due to a 2.1% decline in output combined with a 2.6% increase in the number of hours worked. Productivity is down 2.5% from a year ago and is 1.4% higher than the level right before the pandemic began. The report also showed unit labor costs (how much it costs to produce one unit) increased 10.8% in the quarter, almost 2% more than expected, but slowing from the 12.7% rate in Q1, and is due to a 5.7% increase in hourly compensation and a 4.6% decrease in productivity. This is the largest increase in unit labor costs since 1982. Productivity has been volatile with the Covid pandemic adding to this volatility, but it will take a while before we see the true trend in U.S. worker productivity.
• After months of talking about “peak inflation” we might have finally seen it. After increasing 1.3% in June, consumer prices were unchanged in July due almost entirely to a large drop in energy prices. Bespoke notes this is the largest sequential decline in inflation since at least 1960 (from +1.3% in June to 0.0% in July) Energy was down 4.6% with gas down 7.7%, but these declines were offset by larger increases in food, up 1.1%. Compared to a year ago the index rose 8.5%, down from June’s 9.1% pace that was the highest since the early 1980s. Energy is still 32.9% and food is still 10.9% higher than a year ago. Core prices are still rising, although a slower pace than June with core prices in July up 0.3% and up 5.9% from a year ago, matching June’s increase. The largest category, shelter, was up 0.5%, including owners’ equivalent rent up 0.6% and rent up 0.7%. Electricity has shown consistent increases over the past year, up another 1.6% in the month and 15.2% from a year ago. New vehicle prices continue to rise, up 0.6% in the month and 10.4% y/y. One of the only other notable categories that declined was airline fares which were down 7.8%, however still up 27.7% from a year ago.
• The New York Fed’s survey of inflation expectations shows consumers think inflation will recede in the months and years ahead, most likely due to the drop in gas prices over the past month. The median one-year ahead inflation expectation fell to 6.2% from 6.8% while the three-year expectation fell to 3.2% from 3.6%.
• Producer prices for final demand items were a big surprise to the downside, similar to the CPI report. The producer price index fell 0.5% in July versus the expectation it would increase 0.3% and follows a 1.1% increase in June. The final demand goods index fell 1.8% while the final demand services index increased 0.1%. The index is still 9.8% higher from a year ago, although down from the 11.3% rate in June. Like the CPI, the whole decline was due to a 9.0% drop in prices for final demand energy. Prices for food rose another 1.0%. Excluding food and energy categories, the index was up 0.2% and was still 7.6% higher than a year ago, down from June’s 8.2% rate.
• Jobless claims rose 14k for the week ended August 6 to 262,000. The four-week average was 252,000, up 4.5k from the week prior. The number of people continuing claims was 1.428 million, up 8k from the prior week, with the four-week average up 24k to 1.399 million.
• Prices for U.S. imports fell by 1.4% in July for the first monthly decline since December, while rising 8.8% over the past 12 months, the lowest annual increase since March 2021. The decline was due mostly to a 7.5% drop in fuel prices. Prices of U.S. exports fell 3.3% in July for the largest monthly decline since the first half of 2020. Export prices have risen 13.1% over the past year.

Company News

• Signet Jewelers announced it will acquire Blue Nile, an e-commerce Jewelry retailer, for $360 million in an all-cash deal. At the same time, Signet significantly lowered its full year EPS and revenue guidance that was just provided in June, saying it “saw sales soften in July as our customers have been increasingly impacted by rapid inflation.”
• On Monday, semiconductor company Nvidia preannounced its quarterly results that significantly missed expectations due to a shortfall and slowdown in its gaming chips. Due to the gaming products sell-through projections, the company took actions to adjust channel prices and inventory and said it is slowing its operating expenses in the current quarter.
• After Nvidia’s disappointing quarter, Micron announced the next day due to macroeconomic factors and supply chain constraints it expects a challenging environment over the next two quarters and expects current quarter revenue to come in below the low end of its guidance range provided about 5 weeks ago. It expects shipments to decline in the current quarter which will result in a decline in revenues and margins. Separately, the company said it will invest $40 billion through the end of the decade to build memory manufacturing in multiple phases in the U.S. after the CHIPS Act becomes law, with additional details in the coming weeks.
• In its quarterly earnings calls, GoodRX, the provider of discount cards for prescription drugs, said its issue with a large grocer chain was resolved. It was last quarter the company said the grocer would no longer accept the discount cards which would cause a $300 million impact on revenues.
• Due to “significant material costs increases and other factors,” Ford said it is increasing the price of its electric F-150 Lightning pickup truck. The starting price for the 2023 model will range from about $47,000-$97,000, up between $6,000 and $8,500. The move follows similar moves from competitors General Motors, Tesla Rivian, and Lucid as the industry deals with rising inflation and commodity costs.
• Disney said in its earnings statement last week it added 14.4 million subscribers to its Disney+ streaming service, 31% more subscribers than a year ago and an increase that was much more than expected. It now has 152.1 million Disney+ subscribers. In addition, after adding more subscribers, ESPN+ stands at 22.8 million and Hulu has 46.2 million subscribers. Althgother, these services add up to 221.1 million subscribers, just over Netflix’s 220.67 million global subscribers. Disney also said it would raise the price of each of its options and introduce a cheaper ad-supported option.
• Interactive fitness maker Peloton said it will cut more jobs and close additional stores, adding to an announcement on job cuts it made several months ago. It also said it will raise the price of its fitness bikes.

Other News:

• Fed speak last week indicated officials believe the Fed does not want to declare victory on bringing inflation down yet and reiterates there is still work to do. Several members emphasized rate hikes will continue this year and into 2023 with Bullard calling for a 4.0% federal funds rate by year-end. San Francisco Daily gave more specific comments on the Fed’s next meeting in September, saying she would support a lower 50 basis point rate increase rather than the 75 bps increase the markets have been expecting. Following the recent inflation reports, the market odds for a 75 bps increase in September fell to around 25%, down from around 75% prior to the inflation reports.
• The House voted on and passed the Inflation Reduction Act. The legislation moves to the President’s desk where he is expected to sign into law when he returns from vacation. There has been pushback on the name of the bill, which does not include any specific inflation reducing components, but does include spending on climate change initiatives, healthcare changes such as Medicare negotiations for certain drugs, inflation caps, a redesign of Medicare Part D (prescription coverage), as well as revenue generating initiatives like a minimum corporate tax rate and an excise tax on stock buybacks.

Did You Know…?

Household Debt

Data from the New York Fed shows total household debt rose $312 billion, or 2%, in the second quarter of 2022 (April – June). The total debt owned by households is $16.15 trillion with the largest component being mortgage balances at $11.39 trillion, rising 1.9% or $207 billion from the first quarter. Total debt is $2 trillion higher than it was before the Covid pandemic began. Credit card balances saw their largest yearly increase in over 20 years with aggregate limits on cards the largest increase in over 10 years. Credit card balances increased $46 billion in the quarter but were 13% higher than the second quarter 2021. Auto loan balances increased $33 billion, while student loan balances were roughly unchanged. In total, non-housing balances grew $103 billion, the largest since 2016.

WFG News

Economic & Market Outlook Meeting

Inflation, Recession, Stagflation
What’s Going On?

Tuesday, September 6 – 12:00 pm – WFG Auditorium in Hudson, OH
Thursday, September 8 – 6:00 pm – WFG Auditorium in Hudson, OH
Tuesday, September 13 – 6:00 pm – WFG Auditorium in Hudson, OH

Wentz Financial Group is bringing back its Economic and Market Outlook Seminars the beginning of September! Join us as we recap the first half of the year, explain how we got to where we are today, as well as give our expectation and forecast on the economic and market environment and how that will affect portfolios in the challenging months ahead. We will have three seminar times, one during the lunch hour and the other two in the evening. Please RSVP by responding to this email or by calling the office at 330-650-2700. Seat are limited for each event and will be on a first come first served basis. A buffet style meal will be served approximately 30 minutes before each event.

Career Development Day
Thursday, December 22, 2022 – All Day

Do you know someone in high school or college looking to get real life work experience from the finance industry? Wentz Financial Group will be hosting its 2nd Career Development Day at our office on December 22nd. The day will not only be for those looking to get a first look into financial services field but is open to any student wanting to get their feet in the door of the professional world. Don’t forget to RSVP by responding to this email or calling the office at 330-650-2700.

Office Hours

Please be aware that starting Memorial Day and running until Labor Day, Wentz Financial Group will operate under its summer hours. Our hours on Monday will be 8:30 to 4:00 and Tuesday through Friday will be 9:00 to 4:00. As always, if you need to speak or meet outside of those hours, please reach out and we will be happy to set up an appointment.