Wentz Weekly Insights
It’s All About Inflation

Stocks had a roller coaster week, ending on a more solid note Friday after Fed Chairman Powell said 75 basis point rate increases are off the table for now, but declining 2.4% for the week. The concern continues to be inflation at its highest level since the 1980’s and what is needed to bring that down. Recession, and even stagflation – when the economy sees no growth but high inflation, have been making more headlines in recent days. We do not think a recession is a high probability this year, but as the Fed continues to tighten financial conditions, the probability goes up as we head into 2023.
The highlight last week was the latest data on inflation from the consumer price index (CPI). The index rose 0.3% in April, decelerating from the past several months, but still above the 0.2% increase expected. Compared to a year ago, the index was up 8.3%, down from the 40-year high of 8.5% in March, but again above expectations of +8.1%. Core prices, which exclude the often-volatile food and energy categories, rose 0.6% in April (almost double expectations) and were up 6.2% from a year earlier, decelerating from 6.5% in March.
A lot of talk has been made around peak inflation, but just because inflation is peaking, does not mean it will fall to a normal level any time soon and does not mean the Federal Reserve will slow its path of rate increases. Digging into the details reveals categories that tend to see more persistent price increases remain high, and are even accelerating. The first, and maybe the most important, is housing rents which includes actual tenants and the rental value of owner-occupied homes (instead of calculating just the rise in home prices, the government uses this measure). Home prices are up over 20% from a year ago, but owner’s equivalent rent (the substitute) is up just 4.8%. The category typically trails home price changes by about a year, so we expect this category to accelerate and contribute more to headline CPI over the remainder of 2022 as shelter makes up over 30% of the index.
Other items contributing to the increase was transportation services, up 3.1% in the month and 5.3% from a year ago, driven mostly by airline fares rising 18.6% in the month and 33% y/y, medical services up 0.5% (3.5% y/y), new vehicles up 1.1% (+13.2% y/y), while used vehicles fell 0.4% but still 22.7% higher y/y, and food prices up 0.9% in the month and 9.4% from a year ago. If food and energy prices remain elevated (energy fell 2.7% in the month as oil declined after reaching the highest since 2014), consumers will have to spend more on these categories and take away from discretionary spending that fuels the economy. At the same time the Fed is tightening financial conditions. All of this together will lead to slower growth, but the question is can the Fed bring inflation down without tightening conditions enough that drives the economy into a recession.
It is not just consumers being affected by high inflation. So far this earnings season, a search by FactSet reveals about 380 S&P 500 companies (out of 445 that have reported quarterly results so far) cited inflation on their earnings calls, much higher than the five-year average of 150. Every company in the Materials sector and 96% of companies in the consumer staples sectors mentioned inflation in their calls. The critical part is how that plays into company’s profit margins. For the current quarter, the profit margin for the S&P 500 is expected to be 12.5%, down from 12.7% when earnings season began, suggesting companies are having to lower guidance because of higher prices.
The path of least resistance continues to be to the downside based on last week’s trading. While there have been some reports that retail investors continue to buy the pullback, there may be more room left before a low is hit due to technical data not yet matching prior lows, such as the volatility index, put/call ratio, and the percentage of stocks making new 52-week lows. While we cannot and do not try to time the markets, we do not know if the low is in. In this environment we will continue to favor value and defensive positions, particularly those that pay a steady stream of income through dividends.

Week in Review:

In what seems like a new trend, markets began the week last Monday how they finished the week the Friday prior. All sectors were lower with weak internals and 94% of volume to the downside (second out of the past three days downside volume was at least 90% of overall volume). The path of least resistance continues to be to the downside. Shanghai was reported to have tightened COVID restrictions again, one of the factors leading to a 6% decline in crude oil and a 8.3% decline in the energy sector, making it the worst performing sector for the day. Small caps saw the largest decline out of the four major indices – the Russell 2000 was down 4.51%, while the NASDAQ dropped 4.29% and S&P 500 fell 3.20%.

Tuesday was yet another day of choppy trading that saw a large reversal in markets. Stocks opened higher by over 1%, fell almost 2% from there, and ended up finishing the day up by 0.2%. Growth stocks performed better, helped by a drop in rates, with the NASDAQ higher by 0.98%.

The roller coaster ride continued Wednesday with futures up over 1%, but that was before the inflation report came out at 8:30 am. The consumer price index rose more than expected, although at a slower rate than prior months, leading to investors to believe inflation will not decelerate as much as thought. Stocks immediately moved lower by almost 2% while yields moved higher. However, by the open stocks were much higher as yields fell. But, as we have seen many times in the prior days, stocks reversed course once again and moved lower, finishing near the lows of the day with the NASDAQ losing another 3.18% and S&P 500 down 1.65%.

It was more of the same on Thursday – the producer price index shows inflation remains high for manufacturers, with a 0.5% monthly increase in April (and up 11.0% from a year ago), with stocks opening lower, moving into positive territory by almost 1%, but ultimately moving lower and settling down 0.13% but off the worst levels of the day.

Several short covering moves and Beijing saying it was not facing a similar lockdown to Shanghai helped lead to a higher move in stocks on Friday, despite Powell saying avoiding a recession depends on factors out of his control and admitting rates should have risen sooner. Stocks were able to gain 2.39% but still finished lower for the week.

For the week, the 10-year treasury yield moved in a range of 2.82% to 3.17% but finished the week at 2.94%, crude oil was relatively flat by the end of the week, while the only sector having a positive week was consumer staples as investors moved more defensive. The major U.S. stock indices finished as follows: Dow -2.1%, S&P 500 -2.4%, Russell 2000 -2.6%, and NASDAQ -2.8%.

Recent Economic Data

  • Data from the consumer price index for April showed a year-over-year rate decrease from prior months but remains very high. For April prices rose 0.3%, slightly more than the 0.2% increase expected and follows a 1.2% increase from March. Compared to a year ago the index was up 8.3%, down from the 40-year high in March of 8.5% and above the 8.1% increase expected. Core prices, which exclude food and energy, rose 0.6% in April, above the 0.4% expected and 0.3% from March, while year-over-year was up 6.2%, down from 6.5% in March. The details: food prices were the largest contributor, rising 0.9% in the month (including a 10.3% monthly increase in egg prices due to the rapid spread of the bird flu), new car prices reaccelerated rising 1.1%, transportation was up 3.1% driven by a 18.6% increase in airline fares (up 33% y/y), and shelter (the largest component) rose an unusually high 0.7%. Energy was down 2.7% after 11% increase in March, with gasoline down 5.4% after rising 24.8% the prior two months. Peak inflation may have passed, but that does not mean inflation will come back down to a “normal” level anytime soon.
  • Jobless claims rose 1,000 to 203,000 for the week ended May 7, while the four-week average move about 4k higher to 192,750, both still near historical low levels. Continuing claims for the week ended April 30 were 1.343 million, down 44k from the week prior for another new 52-year low. The four-week average was 1.385 million, down 33k, also a 52-year low.
  • Producer prices rose 0.5% in April, as expected and following a 1.4% increase in March, while producer prices are 11.0% higher from a year ago, above expectations of 10.7%, but decelerating for the first time in over a year from 11.2% in March. Core prices, which exclude food, energy, and trade services, rose 0.6% as expected and are 6.9% higher from a year ago, down slightly from 7.0% in March.
  • Prices on good and services that were imported to the U.S. were unchanged in April, after increasing 2.9% in March, but are still 12.0% higher from a year ago, although down from the 13.0% rate in March. Import prices were held lower overall due to a 2.4% decline in fuel prices, however comes after a 39.2% increase from the prior three months. Export prices rose 0.6% in April, after a record high 4.5% increase in March, mostly driven by a 1.1% increase in agricultural prices. Compared to a year ago export prices are up 18.0%.

Company News

  • Tobacco maker Philip Morris has agreed to purchase Swedish tobacco maker Swedish Match, who is well known in the smokeless tobacco area. The deal will be valued at approximately $16.1 billion in an all cash deal, reflecting a 39% premium to shares of Swedish Match before the deal was announced. Philip Morris does not plan to make changes to Swedish Match’s existing business and said the combined businesses “open up significant platforms for growth in the U.S. and internationally.”
  • Activist investor Macellum, who has been engaged in a proxy fight for Kohl’s, may be losing its battle to overhaul the board at Kohl’s after investors voted to reject all 10 of Macellum’s Board nominees. Kohl’s is still undergoing a strategic review, which includes offers from multiple private equity firms for a complete buyout.
  • Business Insider reported Apple is looking to restructure its services business to break it down deeper including areas such as advertising and streaming. Services has been one of Apple’s fastest growing segments, now generating $19.8 billion in revenues.
  • The NY Times is reporting Netflix is planning to roll out its ad supported streaming service before year end, much sooner than what was expected. It will come at the same time the company is cracking down on password sharing as well.

Other News:

  • The average price of gasoline in the U.S. broke a record last week, with the national average rising to $4.37/gallon, up $0.17/gallon from the prior week, according to AAA. Crude oil declined in April from its March highs over concerns about additional lockdowns in China due to its spread of COVID, particularly in its important manufacturing region of Shanghai. Oil has been on the rise over the past several days again after the European Union’s potential blockage of Russian oil, following the U.S. and other nations that have banned imports of Russian energy.
  • The Department of Commerce is considering a wider ban of American companies selling semiconductor/semi-related equipment to Chinese firms. It would expand an existing ban on U.S. companies selling certain semiconductor equipment to China’s leading chipmaker (Semiconductor Manufacturing International). The reports say the talks are still in the early stages, but could have a larger effect on the equipment makers like Lam Research.
  • Finland is preparing to apply for NATO membership. Russia has sent several warning messages against doing so, saying it would have “catastrophic consequences.”
  • Since the FOMC meeting has passed, the quiet period for Fed members has ended and many speeches have been made last week and will be made over the upcoming days. Atlanta Fed President Bostic said he does not see a need to increase rates 75 basis points, reiterating similar words from Chairman Powell. The next day, Governor Waller said the economy is strong enough for rate increases while saying he prefers to “front-load” increases, then reassess conditions when rates are closer to neutral (when interest rates are not too high to slow growth, but not too low to stimulate the economy and lead to additional price increases). He also said he supports rates over neutral in order to tame inflation, feeling comfortable the economy could handle it. Also, St. Louis President Bullard said he prefers 50 basis point increases and reiterated his stance the policy rate needs to be 3.5% by year-end, higher than most of his colleagues.

Did You Know…?

New Number One:

Due to the recent market pullback, Apple is no longer the most valuable company in the world. Last week Saudi Aramco, Saudi Arabia’s state-owned oil firm, became the largest company by market capitalization. The market cap of Aramco was $2.43 trillion, while Apple was $2.37 trillion. Apple is still the most valuable company in the U.S., followed by Microsoft and Google parent Alphabet.

WFG News

Please be aware that starting after Memorial Day and running until Labor Day, Wentz Financial Group will begin 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.

The Week Ahead

Retailer will be in focus this week as a majority of earnings reports will come from big box retailers. Notable reports this week include Take-Two Interactive on Monday, Walmart, Home Depot, Macy’s, and JD.com Tuesday, Lowe’s, Target, TJX, and Cisco on Wednesday, Kohl’s, Ross Stores, and Palo Alto Networks on Thursday, and Foot Locker and Deere on Friday. In addition, April retail sales is released on Tuesday where economist currently estimate a 0.8% increase in the month as spending continues to shift to services from goods as the economy fully reopens. Other economic releases will show an update on the housing market with the housing market index Tuesday, housing starts on Wednesday, and existing home sales on Thursday. Much focus will be on how the pace of home sales has been impacted by the large increase in home prices and sharp rise in interest rates. Elsewhere, several manufacturing indices are released including the Empire State index and Philly Fed index, along with industrial production on Tuesday and jobless claims on Thursday. There will be several Fed members speaking again this week, most notably Chairman Powell at a Wall Street Conference on Tuesday. Finally, several conferences and investor day events will take place that have the potential to make headlines.