9.1% CPI!

Why didn't markets tank on such bad news?

Jul 18, 2022

Happy Monday everyone. Hope you’re all well. Thanks again for reading. I’ll dive right into this weeks report.

We just received the June monthly CPI print last week, giving us a 9.1% annual inflation rate. Holy shit! Most analysts were predicting 8.6% - 8.8%. Yeah, not so much.

So why didn’t the stock market sell off on this new data? The common thinker would expect the market to tank on such bad news, especially when analysts were predicting a range from 8.6% to 8.8%. After all, higher inflation is bad (really, really bad) which creates a greater need for the Fed to tighten further and increase interest rates. And a further tightening would obviously have a lowering affect on asset prices, i.e., your retirement account (unless you’ve been sitting on cash like I have).

My initial reaction was that stocks would have sold off on this news. But they didn’t. So I started doing some hard thinking (ouch, sorry) and came up with some thoughts on the matter…

Some Thoughts On The Matter…

Okay, so let me walk you through my thoughts on why the market did NOT selloff on this record high inflation and how I’m positioning my portfolio.

Markets are always forward looking…ALWAYS. This is why you often see a stock sell off on good news. This is because the good news was already priced in. Once the news is actually announced, people sell and price goes lower.

The same is true for bad news, but in reverse. “Sell the rumor. Buy the news.”

So with that in mind, let’s look at inflation.

So why didn’t the market tank on 9.1% inflation? I believe because so much bad news had already been baked in. Markets are looking BEYOND this inflation print and what it means to both near term rate hikes as well as the infamous “Powell Pivot”.

Markets are looking to when the FED will pause on rate hikes.

The higher inflation we get, the more aggressive front month rate hikes will be…
The more aggressive front month rate hikes are, the sooner we get to our terminal fed funds rate…
The sooner we get to terminal fed funds rate…
…The sooner the Fed pauses.

And there you have it.

So instead of .50% or .75% hikes over the next two months, maybe the FED does a fierce 100 bps (basis points) in July THEN PAUSES. I think markets are sniffing this out.

This pause will cause markets to soar. This will also be the green light for gold and silver to rip. Why? The dollar seems to be forming a top. Dollar down, commodities up.

Of course, I could be wrong. All of this could turn on a dime. Markets are still overvalued at current levels since they have yet to bring their forward earnings down (generally speaking). Many corporate earnings have yet to guide lower based on higher rates, lower margins and reduced demand (sector dependent, of course). We will find out in the coming weeks as we are now in earnings season.

Remember, we are STILL in a bear market that will trick you from time to time to think it’s over. It’s not.

Back to Fed Rate Hikes…

I’m not smart enough to pretend to know whether the Fed will raise .75% or 1.00% this month…I just use the data given to me and form an opinion.

Remember, The Tobin Report is just that…an opinion. Just because I’m a good looking guy, doesn’t mean I’m a smart guy (insert laugh or smart ass remark). Always do your own due diligence and take what I say with a grain of salt.

As soon as the June CPI was released, the probability of a 1.00% (as opposed to the previously expected .75%) rate hike increased to 92.4%! Those probabilities have since lowered slightly but it tells you something when probabilities of a higher rate hike increase on high CPI print.

You can also monitor these probabilities in real time here via the CME FedWatch Tool.

See below.

Long Story Short

9.1% inflation print may cause the Fed to raise rates faster. This doesn’t guarantee they will; it just increases the probability. And the markets are looking through this. The negative we know is better than the negative we don’t know.

So what has the market been pricing in? Our politicians will tell you the economy is booming and we are at full employment. That’s a crock of shit. They will say anything to get re-elected.

Weak economy - negative GDP in Q1 - negative forecasted GDP for Q2 (by Atlanta Fed, not my neighbor) with a shrinking labor force. Sure, the unemployment rate at 3.6% doesn’t look too bad, but when you look underneath the hood you see that the labor force itself has shrunk dramatically. This is no pinche bueno.
Super duper high inflation. Yes, I said super duper again. Deal with it.
Fed stating they are tightening policy to bring inflation back to 2% (that is LAUGHABLE) and will do whatever it takes. We will see about that.
Weak corporate earnings
Record high debt, both nominal and relative to GDP. THIS is why we can’t raise rates much higher. Think of a credit card…how much higher interest rates can you afford if you owe WAY more than you make?
War in Ukraine
Food shortages
Supply chain issues
Global energy crisis

Good times. I mean, I could go on but you get the point.

Long story short, lots of negative stuff has already been priced in. This is why most retirement accounts are down 15-25%.

What is Smart Money Doing?

What could “smart money” be seeing that the retail investor does not? I believe smart money is seeing inflation peaking. Yes, I just said that out loud. Well, maybe not out loud unless you’re actually reading this out loud. And in that case YOU would have said that out loud. Not me.

Okay, I digress. Back on track…

The next CPI print will be in August, reporting July’s inflation numbers. Could July report a lower CPI? This would indicate a peak in inflation. And IF inflation has peaked, albeit temporarily, Fed policy adjustments will follow.

Let’s take a look:

Copper (industrial use - common indicator) down over 20% in recent weeks
Oil (think gas prices) down 30%+ off its high
Silver prices beaten up, hitting HUGE resistance on the chart, also an industrial use, like copper - indicating recession

What Does All This Mean?

Well, we have already seen prices fall in July. Not all prices within the consumer price index will come down; we just need a few. Food prices still remain elevated. However, demand for many products have been crushed. Oil has come in. Copper telling us demand had fallen. Silver is pricing in a recession. These are things the Fed wants to see…these are signs of inflation coming down.

Housing prices seem to be softening. New mortgage loan applications have cratered. According to Redfin, there have been more price drops in listing prices than any time since 2015. Not earth shattering, but something to watch. Again, another sign we might see some inflation numbers come down. This is what the Fed wants.

Back to Markets.

Inflation hot. Fed hikes aggressively. Markets forward looking. Copper down. Oil down. Silver down. Demand down. Housing softening. Inflation coming down?

Fed eventually pauses on rate hikes. They have to and they will. Multiple indicators tell us components of CPI are coming down. I’m not predicting specific, longer term inflation rates. I’m looking at one or two months of specific components of CPI coming down.

I don’t believe we will see 2% inflation in quite some time, but we could drop to 7%, 6%, or 5% in the coming months. And if this is the case, your amazing politicians will claim victory…just in time for elections in November. And how will they celebrate?

Rate hike pause. Markets will be sniffing this out.

“We are winning on the war of inflation”, they will say. Blah, blah, blah. Remember, they lie. They ALWAYS do. They need you to think they are actually doing their job.

I don’t buy it. Even if the rate of change in inflation comes down, WE STILL HAVE HIGH INFLATION. 7% is still ridiculously damaging to your purchasing power. You need to earn a rate of return equal to inflation JUST TO BREAK EVEN in purchasing power.

But I’ll take it in the intermediate term.

Soooooooooooo, what does this mean for investing and where you should position your money?

I can’t control what our politicians say or do, but by understanding how they think, I can look ahead to what their actions might be and make investment decision based on this…early and before the crowd. Once it’s on the front page of the Wall Street Journal or on CNBC, it’s too late. And if your mailman is talking about it….SELL!!

Smart money always looks around the corner. Smart money is always early. This often means you must take a contrarian view and position accordingly. Don’t invest based on headline news. Invest based on what nobody is talking about.

This also requires buying shares of quality companies that are getting hammered, beaten up, and are unloved.

Summary:

Soooooo, why are markets higher after a 9.1% CPI print? In MY opinion, it’s because they see a pause sooner than originally expected.

Look for quality stocks that are at or near 52 week lows (beat up) that have a good fundamental thesis in the coming months and years. Start accumulating.

Personally, I like the risk/reward ratio in precious metals and miners, including energy, shipping and uranium.

If you can find those, you’re in the right place.

That’s all for now. Thank you again for reading.

Remember, FOMC meeting is next week where the amazing Jerome Powell will shed his wisdom on markets and his master plan for our weakening economy.

Prepare for volatility.

The Tobin Report