I’ve had the privilege of being a CNBC commentator for over 14 years now. Prior to Covid I would often travel to the studios in Englewood Cliffs and participate in a full hour show talking stocks, markets and the economy. Sometimes, I’ll write about how this all came to fruition, which is a fascinating story, however not the point of today’s piece. The last few years my time has been spent on Trading Nation, a daily series discussing market moving stocks or sectors. I can count on one hand the opportunities to discuss a certain subject matter in-depth. Most of the time this dialog is about 45 seconds with a quick opinion on the direction or feel of the tape. Yesterday however, we not only abandoned stocks for economic developments, but I had the rare opportunity to actually dialogue for more than a few seconds about a rather complex subject matter I’ve been writing about for months.
The setup was simple. Unless you’ve been living under a rock, you know that yesterday’s CPI number coming in at 5% was the hottest we’ve seen since 2008. This was after last month’s 4.7% surprise number, which seemed to throw the market for a loop. The reasoning is quite simple to understand. At present, the Fed’s targeted inflation rate is roughly 2%. They’ve not been shy discussing how this will become an ‘average’ and they will take considerable time adjusting rates higher. Any CPI print around this number aligns with the Fed’s thoughts and gives participants confidence that low interest rates and easy money are here to stay. A hot number however doesn’t quite jive with this idea and may give participants pause. Why? Well, if the number is well over the expectations, it may give the Fed reason to abandon their free money policy and adjust rates accordingly. With rates so low for so long, many folks are concerned that this will spark the beginning of the end of the bull market and thus begin selling stocks first and asking questions later.
Yesterday however we saw a 5% CPI print and yet the market ramped higher. This sparked many to scratch their heads over conventional logic. Many were thinking…wait a second, with a 5% inflation rate the Fed is sure to raise interest rates and thus stocks will certainly come down. Yet this didn’t happen.
To understand why this didn’t happen you have to dig a bit deeper into the CPI data released and use some common sense when evaluating whether or not this number is here to stay. Yesterday’s 5% CPI number had a few outliers that can easily be explained. The first was a significant uptick in the price of used cars and trucks. This 30%+ increase accounted for around ⅓ of the CPI number. This is a fascinating data point and is a direct result of a perfect storm in the auto industry. Due to Covid and the resulting manufacturing shut down overseas, we have since seen a semiconductor chip shortage across the globe. This has become so problematic that many new car manufacturers were forced to close their plants and cease manufacturing until they were able to replenish their semiconductor supply. This created an inventory supply problem for auto dealers. Combine this with the fact that stimulus money was free flowing and many folks were in the market for a new (or new to them) car and you have a supply demand imbalance. To maintain some sort of inventory, auto dealers across the country raised used car prices considerably to both capitalize on the significant increase in demand but also to maintain some sort of inventory supply due to a lack of new car inventory. I’d love to take the credit for this understanding, but it just so happens I have a family member who runs a large dealership in Arizona who broke down the challenges for me well before yesterday’s CPI. “Quint, it has gotten so bad that we decided to do a sweeping $1,500 mark up on every single used car on our lot. The next week, we did it again. They’re still buying them left and right.”
As the chip shortage subsides and new car production comes back on-line, the used car market pricing will settle down and this imbalance will likely work itself out.
The other significant uptick was energy seeing a 50% year over year increase. I know so many are quick to point the political finger here but also consider for a moment that last year at this time very few people were driving anywhere. In fact, there was such a decrease in driving many insurance companies issued rebates for unused car insurance. I thought this was incredible by the way. If you didn’t get one, I’d consider a change of provider.
Nonetheless, we’ve now seen hundreds of millions of Americans take back the roadways, hop on planes and begin to emerge from 12 months of hibernation. This increase in travel has sparked a significant uptick in energy prices, which has also contributed to a significant uptick in CPI. Once again, as production comes back on-line this too can be expected to subside and work itself out.
These two primary factors were what sparked such a rapid rise in the CPI and knowing this is a transitory situation is what, in my opinion, gave the market the green light to keep trending higher.
However, this is where it gets interesting and if you notice in the CNBC clip, I not only got to discuss this but also follow it up with a broader thesis that should be noted.
Click the image below to see the clip on CNBC.com or follow the link HERE
When asked what my inflation concerns were, I stated that while these recent items were transitory, I believe the longer-term trajectory is not. To understand this, you must understand the fact that we’re finally seeing increased wage inflation for the first time in decades. This is a result of similar Covid-type factors as well as a direct result of increased money supply; however, unlike used car or energy prices, this is not something that will go quietly into the night. You cannot hire someone on for $X and then suddenly in a few months decide to drop them down to a lower wage. Nor will we see these increased prices which are now being passed on to consumers due to these wage increases being taken away. For example, just because Starbucks has now raised their coffee price by more than 10% for a Grande Pike Roast, they will not suddenly drop this once employment levels off. Nope, these are prices that are here to stay.
What I find so fascinating about today’s economic backdrop is I believe both arguments regarding short-term and long-term inflation are correct and have merit. The Fed, which is stating that much of the inflationary pressures are transitory, is probably correct; however, those concerned with lasting inflation due to the money supply, wage inflation and general price hikes are also, in my opinion, correct.
Our opinion going forward says the following:
1.) I believe the CPI will come back down, at which point the Fed will claim victory over their transitory argument
2.) However, core CPI will continue to creep up sparking a greater, longer inflationary concern.
3.) Markets will remain hot as the inflationary backdrop remains in play and at some point the Fed will be forced to raise rates.
4.) When that happens, the markets will throw a short-term fit but similar to early Fed attempts in the ‘90s, this will be bought up and further empower the bulls.
5.) At some point the Fed will go too far and the inflationary bubble will pop, taking markets with them.
While I have no idea how long this will take to play out, there remain incredible opportunities with a very watchful eye on the interest rate environment and Fed activity. At some point their actions will matter.
Until next time