The Return of the Dreaded “I” Word

From late 2021 until just the last few months, there was ONE word that struck fear into the hearts and minds of Americans and the stock market – inflation! 

In the last 24 hours, with the most recent government report, the dreaded "I" word has become a big topic. 

What is happening, and how much should it impact your trading and investing? 

First – let’s talk about the report… 

On Tuesday, the U.S. government reported its most recent reading on the "Consumer Price Index" or "CPI.”  The U.S. Bureau of Labor Statistics puts out this statistic as an attempt to measure how much inflation there is in the U.S. economy. 

We use "attempt" because it is a very imprecise endeavor. 

Getting an accurate reading on inflation in the real world is complicated. The BLS has to use many statistical methods to try to estimate several of the variables. 

Often, these assumptions can lead to data distortions. This is what happened with the cost of housing for the last few years… 

In this reading, though, we don’t think this was an issue. 

Folks are talking about this reading because it came in HIGHER than expectations. 

On a month-over-month basis, it increased +0.4%, which meant that year-over-year, it was +3.2%. Both of these were one-tenth of a percentage point higher than forecast. 

This higher-than-expected reading set off the pundits on a conversation about the return of inflation! 

Does it matter? 

Our first observation is to look at how the stock market reacted. The answer is – it didn’t really. 

The S&P 500 posted a nice +1% gain, and the other indices were up that day. Overall, it was quite a positive stock market day. 

Contrast this to what would have happened with a similar reading a year ago. The stock market would have been destroyed! 

Is this the proper reaction? We think it is… 

During the period of very high inflation in the last few years, we consistently made two points about the level of inflation. 

The first is that the most negative impact on the real economy was a RAPID rise in inflation. If inflation moves higher but does slowly, it doesn’t matter much to the real economy. 

With enough time, businesses and consumers can react without being shocked. 

The second – and much more critical point – is that the absolute level is what matters most. 

This reading came in higher than expectations and higher than the Federal Reserve’s target rate of 2% inflation. 

Historically, a +3.2% increase in annual inflation is not that high. 

A couple of years ago, we were looking at almost double-digit increases. Now, we are looking at less than one-third of those levels. 

At a high level, lower inflation is better for the economy. However, some levels of inflation are still healthy for growth. 

This number is well in line with the historical averages across the last hundred years. It is a bit higher than some very low numbers we have seen in the past few decades but completely normal. 

We think that the stock market responded precisely right. This report – and the current inflation levels – are not serious issues for the economy, consumers, or the stock market. 

How concerned are you about inflation and its impact on the stock market? Tell us more in the comments section online (scroll to bottom of post).

Can this change? 

Absolutely, and it should be closely monitored. 

A non-consensus view of the primary driver of the recent inflation drives our lower level of concern. 

At the start of the period of inflation, the prevailing view was that the main driver was the issues about restarting the global economy after the COVID shutdowns. 

As inflation persisted and went higher than expected, the view changed to the idea that inflation was primarily driven by increased printing of money. 

Both were always a factor, but our view always held that it was more the first one and not the money printing. 

We think the restart of the global economy took longer and was much more complicated than anyone could have ever predicted. With supply chains now running and adjusted, we don't think we will see a similar situation in inflation. 

Will it exceed the below 2% levels we saw in the last few decades? Maybe… 

It will not, however, in our view, be high enough that it becomes a genuine concern for the economy. 

Listen to the HX Podcast to hear Enrique Abeyta’s conversation with John Roque, Senior Managing Director and Head of Technical Strategy at 22V Research New York.