Markets: Let’s Talk About Inflation (Again)

0

Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.

Week In Review

October 18-24

Let’s talk about inflation. (Again.)

On Friday, Jerome Powell said what everyone else was already thinking: prices are high and rising – perhaps uncomfortably so. The Fed chair acknowledged two facts that investors, consumers and corporate executives had noticed long before: first, that supply chain stress would likely stretch into next year, and second, that inflation is running well ahead of target and may not relent soon enough for some peoples’ tastes[1].

That’s hardly news: things like Purchasing Managers Indices and regional Fed manufacturing reports have been complaining about supply chain stress for the better part of a year, and anyone who has tried to buy a car in the last ten months or so has seen first-hand what a lack of microchips can do to auto production. (And Intel, longtime standard-bearer for all things semiconductor – underscored exactly how long that particular disruption will last when it told investors to expect margins to be squeezed for another two to three years when it released third quarter earnings last week[2].)

But Powell, who has the power to move markets literally whenever the mood strikes him, had only a limited impact on markets last week. Aside from a brief (but notably sharp) drop in stock prices on Friday afternoon, the other big reaction seemed to be in breakeven rates – the difference between rates earned on inflation-adjusted treasury securities and ordinary (or “nominal”) ones that serve as a real-time read the market’s expectations regarding inflation. Breakeven rates spiked higher on Friday, suggesting that Powell’s otherwise only somewhat-noteworthy comments left a mark on one area of the market that still hadn’t gotten the memo. And that equity market hiccup? It was on its way to reversing itself out even before the trading day started on Monday.

If other parts of the market barely noticed it’s probably because inflation fears have become just another part of the current capital market narrative, like supply chain disruptions, labor market disconnects and a mostly dysfunctional policy environment. It’s also likely that Powell’s clearest admission to date that inflation is with us and will be for at least a little while longer did nothing to change the course of Fed policy – the Fed still appears to be en route for a November kick-off to its taper program and Powell’s inflation mea culpa aside, there doesn’t seem to be any urgency to raise rates any sooner than the middle of 2022, perhaps even longer. Hence the muted reaction to Powell’s comments.

So if the Fed’s course is set, then the ball is very much in businesses’ and consumers’ courts with regard to what happens next with inflation. Specifically, if businesses are forced into a corner by rising raw material costs and persistent labor shortages and start doing things like boosting wages or selling prices faster than they already are, then inflation could be with us longer than even Powell’s comments suggest. If, on the other hand, businesses hold the line and take rising costs into their financials as a matter of course, then they might be placing their own corporate margins at risk. Doing that would in turn put earnings growth at risk, possibly pressuring markets that are still priced as if earnings will continue to grow to the sky. It’s a real dilemma.

And for what it’s worth, more than a few companies passed on the opportunity to boost guidance meaningfully when they reported earnings last week. Beyond Intel’s margin-driven guidance disappointment described above, companies from industries as diverse as consumer, airlines, finance and rails all quietly put away their rose-colored glasses. Markets paid attention to some of those reports and mostly ignored others, and the tendency to forego rosy forecasts was far from universal, but from where I sit, it seems that guidance has been somewhat underwhelming so far during this quarter’s earnings season.

But what about consumers? If businesses have the ability to influence the impact inflation might have on markets by way of things like tepid earnings forecasts and wage and price growth acceleration, how can consumers wield similar influence? Well, one thing that has so far been mostly absent from the post-COVID recovery and its trend toward higher prices is the kind of panic-buying that ignited the inflationary spirals of the 1970s: basically, a buy-it-now-or-pay-more-tomorrow mindset that can take a smoldering heap of price pressure and turn it into a full-on wildfire.

So far, that hasn’t happened. And it doesn’t appear imminent, either: the University of Michigan’s consumer sentiment team in particular has made that point several times during it’s closely-watched consumer sentiment report more than once[3]. But that doesn’t mean consumers aren’t paying attention: the same UofM survey – and others like it – have noted that higher prices are currently having the opposite effect, causing consumers to rein in purchases of big-ticket items in particular as they wait for things like supply chain stresses to relent (and you could make a similar argument surrounding the now well-documented slowdown in housing markets.)

Of course, one of the things that might alter that thinking might be energy prices – and they haven’t relented. While last week didn’t really produce any eye-catching gains, a longer look is a little more surprising. Through Friday, crude oil is up more than 50% this year, while wholesale and at-the-pump prices for gasoline are up 60% and 42%, respectively[4]. Possibly even more concerning are natural gas prices, which have more than doubled this year – if La Nina has her way and most of the country enjoys a warmer-than-usual winter[5], then prices could relent (especially since gas inventories in the US are almost spot-on seasonal averages[6].) But if not, utilities bills could be going higher.

But does any of this matter? After all, we all know that economists are famously willing to look the other way when energy prices move in one direction or another. But consumers are perhaps more fickle: the concept of core inflation versus headline inflation seems hopelessly academic when it suddenly costs a lot more to fill your gas tank or heat your house. Whether or not that eventually translates into the kind of self-reinforcing inflationary wildfire is one of the key questions as we look into what lies ahead for markets during the fourth quarter and beyond.

As you can probably tell from the amount of space devoted to the inflation discussion above, there wasn’t a ton of stuff to write about last week from an economic perspective. That said, a few odds-and-ends probably deserve mention, starting with flash Purchasing Managers’ Indices (PMIs) from Markit Economics[7]. But even that report held few surprises, perhaps the most significant of which was a widening gap between services (which is ascending) and manufacturing (which seems to be cooling.) That squares pretty well with the most common view of the economy in which demand for goods was pulled forward during the early stages of the post-COVID recovery but is now tapering off, while demand for services is improving as fears surrounding the virus and all its manifestations is fading. Beyond that, last week’s PMIs were pretty unremarkable insofar as the current litany of issues (labor, supply chains, prices…) continued to dominate the associated commentary. That was true for the Philadelphia Fed’s regional manufacturing report, too, which together with the Fed’s Beige Book[8], suggested continued expansion but at a slower pace[9].

If there was a surprise in the data, it was a favorable one: weekly jobless claims declined to 290,000, the second consecutive week below 300k and the lowest reading since the pandemic began[10]. The housing market, too, was home to a mild upside surprise: buyers purchased existing homes at a faster-than-expected annualized pace of 6.3 million units in September, but inventories continued to contract slightly.[11] That matters, because if more homes aren’t made available to would-be buyers, then housing could cool even further given what appears to be homebuyers’ newfound religion on pricing. And on that score, the news was less optimistic: starts and permits were both below expectations and are now well below their cycle peaks[12].

What to Watch This Week

October 2531

Notable economic events (Oct. 2529)

Monday: Dallas Fed, CFNAI, FB earnings

Tuesday: Home prices (x2), Consumer Confidence, New Home Sales, Richmond Fed; GOOG, MSFT, AMD, UPS

Wednesday: Durable Goods Orders, EIA inventories; F, GM BA, KO and MCD earnings

Thursday: 3Q GDP, Pending Home Sales, ECB decision, Weekly jobless claims, ECB; AAPL, AMZN earnings;

Friday: Personal Income/Outlays, UofM Sentiment, oil majors earnings

Unlike last week, there’s a full economic calendar to keep everyone busy. Housing data will continue to roll in, with pricing data on Tuesday (although as usual it will be lagged by a month and therefore not immediately impactful,) along with new home sales volumes and pending transaction data for September (Thursday.) As before, the main question isn’t whether the once white-hot housing market has cooled, but rather by how much.

There are also a few more regional Fed manufacturing reports to parse through, including Dallas on Monday, Richmond on Tuesday and Kansas City on Thursday. Ordinarily these reports provide among the clearest insight into what’s going on inside the economy, but these days they are often just a repeat performance of previous reports showing robust demand constrained by supply chain difficulties, labor market stress and pricing pressures. Expect more of that this week.

A bit more interesting are a pair of consumer confidence reports, beginning with the Conference Board on Tuesday and ending with the University of Michigan on Friday. Together, these two reports form the core of consumer-attitude reporting for the US economy and both have been on the wane. We will watch these reports closely for evidence that consumer attitudes are changing as a result of inflation, labor market issues or policy dysfunction.

But the real news from a planned release perspective will be Friday’s personal income and outlays report. That serves as an important cross-check on whether consumers who respond to surveys like the Conference Board and the UofM are actually doing what they tell pollsters they are doing by detailing exactly where and how much they are earning and spending. More important to today’s environment, though, will be the so-called PCE price index that appears inside that report. It’s become a popular way for market participants to look at inflation given the Fed’s preference for it as supplement (or an alternative) to more commonly followed CPI and PPI data. Similarly, inflation-watchers will hungrily scan Friday’s employment cost index – a quarterly release from the Federal Reserve that captures both wages and benefits – for signs that inflation is starting to creep into areas that are more sustainable in nature.

Finally, this week will mark the first real growth-focused week of third-quarter earnings season as the baton passes from financials and other mundane sectors of the economy to technology, communications and discretionary. While there are too many notable reports to list here, key reports this week are expected from the majority of the so-called FAANGs (Facebook on Monday, Google on Tuesday and Apple and Amazon on Thursday.) Add to that Twitter and Microsoft on Tuesday, as well as a select few chip-oriented companies scattered throughout the week, and we should have a pretty good idea of how the higher-growth portions of the economy are holding up when the dust settles on Friday[13].

For those of a more industrial bent, automakers GM and Ford report on Wednesday, followed by equipment maker Caterpillar on Thursday. These companies will give a good read-through into how the ongoing chip shortage is impacting production as well as the always-important view into demand for things like cars and earth-moving equipment. Then on Friday, oil majors like Exxon-Mobil and Chevron will give their view on how the surge in energy prices looks from the luxury box. Other earnings reports abound, with more than 200 companies expected to release results on both Wednesday and Thursday. While the FAANGs, chipmakers, automakers and oil majors will get most of the attention, any one of the 800 or so companies expected to report this week could have something to say that alters how investors are looking at the environment. So stay tuned.

 

Want to better manage your investments? Millions of people use Personal Capital’s free and secure online financial tools to see all of their accounts in one place, analyze their investments and uncover hidden fees, and plan for long-term goals, like buying a house or saving for retirement.

Get Started with Personal Capital’s Free Financial Tools

Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.

[1] https://www.investors.com/market-trend/stock-market-today/dow-up-nasdaq-falls-on-powell-speech-social-media-stocks-sell-off-on-snap-earnings-tesla-breaks-out/ [2] Bloomberg, Zacks.com, company reports. [3] http://www.sca.isr.umich.edu/ [4] Data: Bloomberg, American Automobile Association, Energy Information Administration, GWI calculations [5] https://www.noaa.gov/news-release/us-winter-outlook-drier-warmer-south-wetter-north-with-return-of-la-nina [6] Energy Information Administration [7] https://www.markiteconomics.com/Public/Home/PressRelease/291a6f7539534735b69350b6e4e0f921 [8] https://www.federalreserve.gov/monetarypolicy/files/BeigeBook_20211020.pdf [9] https://www.philadelphiafed.org/surveys-and-data/regional-economic-analysis/mbos-2021-10 [10] https://www.dol.gov/ui/data.pdf [11] https://www.nar.realtor/newsroom/existing-home-sales-ascend-7-0-in-september [12] https://www.census.gov/construction/nrc/pdf/newresconst.pdf [13] Zacks.com