U.S. households need to know if inflation has peaked. Higher costs could have dire consequences for the pocketbooks of American families. Proper budgeting is critical for many.
For investors, answering the question, “has inflation peaked?” is important because the Federal Reserve is on a rampage to squash inflation. The Fed’s primary tool is raising interest rates, which doesn’t allow stocks to increase their prices as rapidly as they might otherwise—if at all.
For July 2022, year-over-year inflation was 8.5%. That was down from June’s Consumer Price Index (CPI) inflation growth of 9.1%, which was its highest since April 1981. Although there seems to be some relief from out-of-control inflation growth, investors must still contend with how the Fed will combat inflation. Rising interest rates weigh on the stock and bond markets as the Federal Reserve tries to bring inflation closer to its two-percent target.
The “good” news is that the Federal Reserve’s preferred inflation measure is the core personal consumption expenditures (PCE) metric. (As with the CPI, the “core” version excludes food and energy prices because they are relatively volatile.)
What is the difference between CPI and PCE?
The Federal Reserve prefers to use the PCE to track inflation because it is a timelier measure of consumer behavior than CPI. The CPI and the PCE represent a basket of goods and services that consumers would buy. The CPI basket does not allow for substitution, despite price changes, while the PCE tracks a broader range of goods and buyers to track what is actually purchased. In real life, if beef prices go up, people might buy more chicken. Or, if gasoline prices rise, drivers might take fewer road trips. The CPI doesn’t adjust for those consumer behaviors.
Year-over-year core PCE for June was 4.8% (July’s number will be reported on August 26, 2022). That is down from 5.4% in February 2022.
Non-core PCE should be down considerably in its next reading. There was an agreement that removed a Russian blockade on the Black Sea that was blocking grain exports from Ukraine, crushing supply, and skyrocketing food inflation. Also, oil and gas prices have dropped considerably.
Why are Gasoline Prices Lower?
The highest recorded national average price of regular gasoline was $5.016 on June 14, 2022, according to AAA. As of August 10, 2022, the price was down to $4.01.
Anyone who has ever traded a meme-stock knows that prices are not always grounded by the immutable, long-term Law of Supply and Demand. The action of gas prices might have looked rather meme-like on their rapid trajectory higher. Still, the decline over the past two months is rooted in fundamentals. Gasoline demand dropped while inventories climbed. Inventories rose due to improvements in supply chain issues that roiled oil refineries in the wake of the COVID-19 pandemic closures.
Gasoline inventories climbed in June and July 2022, reaching 26.2 days of supply as of August 8, 2022. That is up from a low of about 24 days of supply two months ago. The jump of two days of supply in two months is the largest increase on record. Not only did supply rise, but it rose during months when supply typically dives.
Other PCE components are experiencing declining prices, too. The July PCE won’t be close to 2%, but it’ll get to that level sooner than CPI because it will reflect actual household purchases. We don’t need to see that shockingly high CPI number get cut by nearly four-fifths, down to a two-percent rate, before the Fed can relax from hiking rates. Still, there’s a lot of wood for the Fed to chop. The Fed isn’t done forming headwinds against the markets just yet.
Is This Just a Bear Market Rally?
The stock market has had an impressive run since its mid-June low. As I write this column, the S&P 500 popped over 4,200 points after a lower CPI report than last month. The index is approaching 4,231. That’s relevant because it represents a 50% retracement from the bottom back to its previous high. Since 1950, no bounce has exceeded a 50% retracement and then gone back to make new cycle lows. The stock market is currently over-extended, and some short-term consolidation is likely throughout the next couple of months. Popping above 4,231 wouldn’t save stocks from that compression. However, it would suggest that stock investors have endured the worst of this cycle.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures: https://berkshiremm.com/capital-ideas-disclosures/ Direct inquiries to Allen at AHarris@BerkshireMM.com.
