Positive signs emerge on inflation, but will it last?

Our Top Market Takeaways for August 12, 2022

Market Update: Price relief

The July Consumer Price Index data was a crescendo to a string of better news for investors. The closely watched inflation metric showed that there were not any price gains in July (compared with a 1.3% increase just last month), and even after stripping out food and energy costs, prices only rose by 0.3%.

Falling oil and gasoline prices had a big impact. Prices at the pump have declined for 57 straight days, and the national average is below $4 per gallon for the first time since early March. In all motor fuel costs fell by 7.6% on the month. Lower fuel costs also gave travelers some relief. Airfares fell 7.8%.

Lower energy prices should continue to flow through the supply chain. Indeed, global shipping costs are now down almost 40% from their peaks, and producer prices (which measure inflation facing businesses and manufacturers) was actually negative in July relative to June. All of this suggests that goods inflation should continue to fall over the next few months.

But it wasn’t just energy. The share of components within the CPI index that saw price declines was the highest since early 2020.   

This CPI print is the latest (and most important) indicator that suggests price pressures have peaked. The pace of wage gains have cooled no matter which data series you look at, consumer expectations for future inflation are falling, and market-based measures of inflation remain anchored.

While all of this is encouraging, we aren’t out of the inflation woods. Prices are still much higher than they were a year ago, and core inflation of 0.3% per month still implies an annual pace of inflation well above the Federal Reserve’s target of ~2%. Housing costs continued to rise and will likely do so for a while longer. Food prices were up a staggering 1.1% in July and are now almost 11% higher than they were last year, posing a burden to many families.

We expect the Fed’s hiking cycle to continue until they see additional convincing evidence that inflation is moving back towards their target, even if the hikes are at a slower pace than the 75 bps moves we saw in July and August.

That said, markets are starting to sense a shift. The S&P 500 continued its rally from the June lows this week, the treasury yield curve steepened, and both high yield and investment grade credit spreads tightened. All three are signs that the Fed may not have to force a recession to cure inflation after all. Further, the assets that have been at the epicenter of this current bear market, like the ARKK Innovation ETF (~+50%) and the NASDAQ Composite (~+20%) are well above their lows. Investors shouldn’t let their guard down, but we do see more signs that we may be through the worst of the bear market (absent a recession).

At least, July’s 528k job gain coupled with no inflation showed that a soft landing is still very possible.

Investment Implications: Taking stock of your plan

The summer stabilization could give you an opportunity to take a look at your portfolio on a holistic basis. Through all of the day-to-day volatility in markets and uncertainty over economic data, we seek to build portfolios that allow investors to reach their financial goals with an appropriate amount of risk. The late summer could provide an ideal time to reflect on the market volatility that we saw over the first 7 months of the year and think about whether your portfolio still matches your own risk tolerance.

You may also have time to update your goals-based plan. Doing so can help you understand how your portfolio may react to the potential bouts of market volatility ahead, and determine whether or not you are still on track to meet your goals.

We are using the time to take stock of our views on markets. In equities, we are making sure that we have a proper balance between sector, style, size and geography. Further, we are exploring the best ways to hedge exposures through options, structured notes or managed strategies in an effort to add more certainty to potential outcomes. In fixed income, we still think that many parts of bond markets provide an attractive entry point, especially for those looking for a buffer against potentially adverse economic outcomes given the amount of tightening that has already taken place.  

As always, we are looking for opportunities. Structured equity in dislocated sectors and preferred equities are currently in focus, and we continue to work on small and mid-cap equities, which are trading at historic discounts relative to large cap, and well below their own averages.

Hopefully you find some time to rest and relax over the next few weeks before what ought to be an eventful autumn.  

All market data from Bloomberg Finance L.P., 8/11/22.