Wentz Weekly: Inflation Data Leads to Another Roller Coaster Week, We’re Not Off The Ride Yet

Wentz Weekly Insights
Inflation Data Leads to Another Roller Coaster Week, We’re Not Off The Ride Yet

Elevated volatility continued last week as markets reacted to several key inflation readings. The volatility index (VIX) traded in a range of 28 to 35 last week, versus its 50-day moving average of 26. Stocks were on track for their seventh consecutive day of declines last Thursday after the consumer price index was released in the morning that showed a hotter than expected 0.4% increase in September. Inflation was expected to cool in the month, thanks to lower energy prices which fell 2.1% in the month, but a larger increase in other categories more than offset any drop in energy prices.

Compared to a year ago prices across the board were up 8.2%. This was also higher than what was expected and, thanks to energy prices coming down, was down from 8.3% in August. As we have talked about and are seeing more of, inflation is showing more in the service sector and areas where they tend to be more persistent, instead of categories like energy and commodities where they move higher faster but come down quicker. Food prices have increased at least 0.8% for 12 of the past 13 months and are 11.2% higher than last year. Transportation costs were up 1.7% in the month, while shelter costs, which make up nearly one-third of the index, rose a very strong 0.8% for the largest increase in about 30 years as rents (and owner equivalent rents) catch up to the increase in home prices we have seen the past 24 months.

Stocks originally moved significantly lower while bond yields jumped higher, but this was short lived. As the day moved on stocks moved higher and by the end of the day rallied over 5% from its early morning lows to finish higher. Most of these gains were given up Friday though after a consumer survey showed inflation expectations moved higher for the first time in a couple months. Data on actual inflation is one thing but expectations are the second part of the picture. We know from history when people think inflation will move higher it becomes self-fulfilling as they spend more today because they believe things will be more expensive in the future which exacerbates the price increases.

The data supports a higher rate increase in the Fed’s November meeting, with market participants now beginning to price a higher increase in the final meeting of the year in December as well. Futures markets are pricing a 5.0% interest rate by the first meeting of 2023, which would put 500 basis points (5%) worth of increases in a 12 month period. Equity and fixed income investors have been repricing for this environment with higher bond yields and lower equity valuations.

This week, and the next couple weeks, investors will get a better idea of the earnings part of the picture. Focus will shift from inflation data last week to earnings this and the next several weeks as earnings season ramps up. Banks kicked it off last week with results not as bad as feared, but earnings expectations continue moving lower. Average earnings estimates are down 7% compared to when we started the quarter, higher than the average 4% decline we see.

We will be paying attention to commentary on inflation, higher costs, employment trends, and margins as the strong dollar will likely impact profits. As noted in Barron’s, about 30% of S&P 500 company’s revenues are generated overseas. As these sales are converted to dollars, they make overseas earnings look less, impacting profits. It notes earnings estimates for companies with domestic sales moved 1% lower while companies with non U.S. sales (73% of the index), earnings moved 4% lower.

While a short term bounce may be likely over the upcoming weeks from supportive technical data, we continue to expect a rocky ride over the next 12 months as market participants continue to assess inflation, interest rates, recession chances, and the trajectory of earnings. For now, with rates higher and yields more attractive, money markets continue to look like a good place to park cash.

Week in Review:

Stocks got off to a quiet start to start the week with a lack of any notable headlines as markets were in waiting mode for the FOMC minutes and inflation data later in the week. Fedspeak included remarks from Vice Chair Brainard that reiterated her colleague’s stance that it will take time with tighter policy to reduce inflation, while saying the central bank is attentive to risk events that could become amplified. JPMorgan CEO Dimon received attention after his remarks that current economic conditions are likely to push the economy into a recession over the next six to nine months. Defensive sectors were positive for the day while the broader markets down 0.75%.

Markets started on a cautious note on Tuesday after the Bank of England expanded its bond buying to include inflation-linked bonds after seeing “a further significant repricing of UK government debt” that involved another sharp move higher in yields, leading to additional concerns about market stress. Stocks were unable to maintain its mid-day gains, after being up 0.78% midday, and ended lower for the fifth consecutive day with the S&P 500 down 0.65%.

Stocks traded in a much narrower range on Wednesday compared to recent days, however still moved lower with the S&P 500 and NASDAQ at their lowest close since November 2020 and July 2020, respectively. The producer price index came in hotter than expected for September, but markets only saw light selling from the report as it looked forward to the more important CPI report on Thursday. Helping asset prices somewhat was reports that UK officials could adjust its recent fiscal package along with optimism the Bank of England could extend its bond buying.

Premarket futures were higher Thursday but that was until consumer price index data in the morning showed higher inflation than what was expected, leading to additional concerns of tighter monetary policy by the Fed. Stocks hit a new low of the year right at the open, down 2.4% at the low, but shortly after started a massive reversal and by the end of the day rallied over 5% to finish the day 2.8% higher. There was no clear catalyst, but the most probable excuse is technical factors and possibly that financial stability in the UK markets were improving.

Markets were trading mixed in premarket action on Friday but moved lower after the Consumer Sentiment report showed consumer’s expectations on inflation over the next year moved higher for the first time since March. The other big news of the day was UK Finance Minister being dismissed and UK Prime Minister Liz Truss announcing a reversal of the fiscal plan that originally called for lower tax rates. Elsewhere, September retail sales were unchanged, a little weaker than expected, but the index excluding gas and vehicle sales was higher than expected. Stocks gave back most of Thursday’s gains and close lower by 2.37%.

Treasury yields moved higher on the short end and were fairly level on the longer end of the curve last week while the major U.S. stock indices finished as follows: Dow -1.15%, Russell 2000 -1.16%, S&P 500 -1.55%, and NASDAQ -3.11%.

Recent Economic Data

• The producer price index, an index that measures the prices changes of domestic producers of goods and services, rose 0.4% in September, doubling the expectations and follows a 0.2% decline in August. Compared to a year ago, the index was 8.5% higher, also above expectations but slower than the 8.7% rate from August. Food and energy drove much of the monthly gain, up 1.2% and 0.7% respectively. Stripping out the volatile food, energy and trade services categories, the index was up 0.4% in the month for its largest monthly increase since May and was up 5.6% from a year ago, matching August’s pace.

• The consumer price index showed consumer inflation rose 0.4% in September, doubling the expectations of a 0.2% increase and were 8.2% higher than a year earlier, also higher than expected, and follows a 8.3% increase from August. The food category continues to increase at a high and persistent rate, rising 0.8% in the month and increasing at least 0.8% for 12 of the last 13 months. Energy prices had a downward impact on prices in September, falling 2.1% in the month. Core prices, which exclude food and energy categories, rose 0.6% in the month, higher than the 0.4% expected and matching the prior month’s increase. Compared to a year ago core prices are up 6.6%, higher than the 6.3% increase in August and also above expectations. Prices in categories that are more persistent are beginning to creep higher. Shelter costs were up 0.7%, household furnishings up 0.7%, transportation costs were up 0.7%, transportation was up 1.9%, and medical services were up 1.0%. New car prices were up 0.7% as supply shortages persist, while used car prices cooled 1.1%. The report showed more inflationary pressures than expected, which will keep the Fed on path with aggressive rate increases and continue to pressure asset prices.

• The New York Fed survey of consumer expectations showed consumer’s inflation expectations over the next year fell to 5.4%, from 5.7%, for the lowest reading since last September. The three-year ahead inflation expectation rose slightly to 2.9% from 2.8% while the five year expectation rose to 2.2% from 2.0% after seeing a decline in the previous month. In addition, forecasts for household spending growth over the next year fell sharply from 7.8% to 6.0% for the largest one-month decline since 2013.

• The number of jobless claims filed the week ended October 8 was 228,000, a rise of 9k from the week prior and rising from a recent low of 190,000 from two weeks prior. This brings the four-week average to 211,500, up 5k from the prior week. Continuing claims totaled 1.368 million, relatively unchanged from the week prior with the four-week average moving 8k lower to 1.364 million.

• Retail sales for September were unchanged at $684.0 billion, a little less than expected, but still 8.2% higher than a year earlier. About half of the 13 major categories saw increases in the month, which were more services related, including food stores, bars and restaurants, general merchandise stores, and health/personal care, while more of the goods related categories like vehicles, electronics/appliances, and building materials saw declines. Core sales, which exclude the more volatile categories like vehicles and gas, were solid, rising 0.3% in the month and 7.5% higher than a year ago.

• The University of Michigan’s preliminary index of consumer sentiment for October was 59.8, higher than the 59.0 expected, rising from 58.6 last month, and higher than the all-time low of 50.0 in June. Current conditions improved to 65.3 from 59.7 while expectations fell to 56.2 from 58.0. The more important part for the markets was the one-year ahead inflation expectation moved to 5.1%, up from 4.7% in the prior month, while the five year ahead inflation expectation increased to 2.9% from 2.7%.

• The minutes from the most recent FOMC meeting were just about as expected, with Fed officials sticking with their message that rates will have to move to a restrictive stance for some time to cool inflation. It was noted policymakers agreed that the cost of taking too little action outweighed the cost of doing too much, but did note this risk would become more two-sided as policy moves more restrictive.

Company News

• Netflix announced it will price its ad-supported service at $6.99 per month, making it competitive with Disney+ and Hulu ad-supported service at $7.99 which launch in December, and higher than Paramount+ and Peacock that price at $4.99 per month. The company plans to roll out the service on November 3. The service will not give the ability to download shows to watch later. Its ad service will include 15 to 30 second commercials that will play before and during shows and will average 4 to 5 minutes per hour.

• Chipmaker Intel said it will cut thousands of jobs as it faces a slowdown in the PC market with some of its divisions cutting as much as 20% of its staff. As of 2022 it employed just over 110,000 people.

• After rumors surfaced Thursday, Kroger announced on Friday is agreed to acquire the grocery chain Albertsons for $34.10 per share, valuing the company at about $24.6 billion. The deal includes Albertsons’ debt and a special cash dividend of up to $4 billon.

Other News

• Early last week, the Bank of England expands its emergency bond buying as an extension of its support to pension funds and the financial markets to prevent a “fire sale” and contain the bond market selloff that has threatened UK financial markets. It said the move came after it saw “a further significant repricing of UK government debt, particularly index-linked gilts.” It said it will widen its scope of intervening in the markets by announcing its purchases would now include inflation-linked bonds following another sharp rise in yields. It ruled out extending the bond buying beyond the Friday expiration and told pension funds to rebalance and close out positions they could not maintain. This follows news from Monday that it would double the total daily amount of bonds it could buy. Mid-week, a report from the Financial Times said the Bank of England hinted to banks it may extend the bond buying, but it ultimately let the program terminate.

• UK Finance Minister Kwarteng has been dismissed from office after just 38 days in the position. This comes after him and Prime Minister Truss decided to take action, and follow through on something that got them elected, to promote economic growth by announcing their plans to cut taxes. The proposal caused chaos for the markets, with UK government bond yields spiking, leading the Bank of England to intervene and begin buying bonds to support market functioning, and eventually leading to backlash from many Conservative members of Parliament.

• JPMorgan CEO Jamie Dimon received a lot of attention early last week with his public remarks – saying current economic conditions, with high inflation, rising rates, quantitative tightening, and the war in Ukraine, will push the economy into a recession likely in the next 6-9 months and suggested the markets could become disorderly as volatility increases.

• Covid worries made a return in China, particularly as its government reiterated its zero-Covid policy. News of several positive cases had markets on alert as Shanghai conducted mass testing and ended up ramping up restrictions by the end of the week as cases were the highest since mid-July.

• Recent Fed speak:
• Chicago Fed President Charles Evans said the Fed can lower inflation relatively quickly while avoiding a hard landing. He said he believes the Fed needs to raise rates further and hold them at those higher levels “for a while” to accomplish this.
• Fed Vice Chair Lael Brainard said it will take some time for tighter policy to work to reduce inflation and the moderation in demand from tighter policy is only partly realized, and the effect on prices will take longer. Says with slower output growth we are seeing tentative signs of rebalancing in the labor market. Says the Fed will move forward in a deliberate, data-dependent manner. She says there are increased concerns about a “sharp decrease in risk sentiment or other risk event” that could become amplified given the fragile liquidity in financial markets.

Did You Know…?

• Will your primary doctor still accept you Medicare Advantage Plan?
• Have your medical needs changed? Different plans offer different benefits and different costs
• Are there comparable, lower cost plans available? Don’t forget to consider out-of-pocket costs when comparing options
• Are you medications still on your plan’s list of covered medications?

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