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1) CPI comes in softWednesday’s CPI report was a big relief for the Fed after 4 consecutive upside surprises. The key metric was core CPI which came in at 3.62% year over year vs last month’s rate of 3.8%. This continues the clear downward trajectory that was so dominant last year. There were broad signs of weakness in the report with slowing rates of change in durables and services, but shelter remains a sticking point. The shelter component is still coming in at 5.5% year over year, well off its highs, but still way above readings we’re seeing in more real-time rent indicators. As I’ve mentioned many times in the last year this component intentionally lags and at 45% of the CPI it’s by far the largest component. In my view, its direction in the coming year is what will drive the direction of CPI.
Here’s how I see this playing out. This is oversimplified, but rents are largely tethered to wage growth. In other words, shelter prices will tend to correlate with rents, but rental prices are ultimately a function of how much the renter can actually afford. So these two datasets will tend to revert towards one another over time. The current environment is one in which wages are dropping towards their pre-Covid levels and I expect them to drop to the 3.5% range before year-end. With rents growing at 5.5% there’s still a meaningful disconnect there between the lagging rent data and actual wage growth. This should continue to put downward pressure on the rental data in inflation and could continue for upwards of another year. In other words, there’s still a large downward tailwind to the disinflation trend that’s been in place and the only way I see that reversing is if we get something highly unusual like a big commodity price boom.Long story short – inflation continues to move in the right direction. It’s not moving as fast as many would like, but the progress is still clear and should continue. I don’t think this changes the baseline case for a November rate cut, but it certainly reinforces the view that we’re not seeing a second big flare up in inflation that would warrant rate hikes. And of course, this still leaves the next Fed move squarely in the cut camp. I don’t think it’s a matter of if, but when at this point.
2) The Stock Market “Casino”Dave Portnoy of Barstool Sports fame had a video on Twitter calling the stock market a rigged casino. Dave sometimes posts content as “Davey Day Trader” in which he trades in and out of positions over short time horizons. Dave is obviously very good at making money, but I think he could benefit from viewing his stock portfolio more like he views his actual business and the way a business grows over very long time horizons. And Dave isn’t the only one of course – the idea that the stock market is a casino is disturbingly commonplace. Heck, if you watch financial TV or listen to Wall Street analysts you probably think the time horizon of the stock market is 1 day or 1 year. And when you trade it in such short time horizons you are effectively treating it like a casino and turning the market makers, brokers and government into the house by letting them kill you with taxes and fees. You’re playing a zero sum game rather than letting the stock market accrue the returns that makes it a positive sum game. The reality is that the stock market is a long-term instrument and it takes a very long time for the underlying entities to accrue and pay out their profits. In my Defined Duration model it’s currently a 15 year instrument that will generate about 6.2% over the future 15 year period. But in order to actually capture that average return you need to be willing to hold the asset for most of that 15 year period.The only instruments that can reasonably be viewed as daily instruments or even annual instruments are super safe instruments like cash, money markets or T-Bills. Those are your short-term instruments. Everything else is inherently longer. Even the aggregate bond market is an instrument with an average duration of 6 and I’d argue that in the current environment you need to be willing to hold that instrument for at least 3 years to have any certainty of future returns. And if you take a multi-asset instrument like a stock/bond fund (such as 60/40 or 40/60) you’re essentially blending the 15 and 6 year durations which gives you a combined duration of something close to 10 years. In other words, all of this is pretty long-term by design. You don’t have a great deal of certainty in the near-term when you buy stocks because stocks are very volatile in the short-term and much more reliable in the long-term.The bottom line is that anyone day trading or even trading the stock market is trying to turn water into wine. They’re taking an inherently long-term instrument and trying to force it to generate a return that it mathematically cannot provide to all investors in the short-term. This is a big reason why I’ve become such an ardent advocate of strategies like the Defined Duration strategy. Not only is it based on an underlying financial plan, but the strategy properly matches your asset allocation to a specific set of assets that give you the proper perspective on your portfolio and how you can better maintain discipline inside of those time periods to allow the assets to do what they’re designed to do.
3) The Stagflation NarrativeMy friend Warren Pies had a good tweet about the stagflation narrative. In short, lots of people are calling this a period of stagflation, an environment characterized by high inflation and low real growth. But Warren points out something important – stagflations are usually supply chain constrained environments where you get cost push inflation. The 1970s were a classic stagflation where the dominant driver was the cost of oil rising so fast due to supply constraints that you had costs pushed onto consumers. This resulted in a lot of economic instability, high unemployment and high consumer prices. This is not what’s happening today.To be clear, yes, we have low historical growth. RGDP has averaged just 2.3% since 2022. It averaged 3.2% from 1948-2022. So we’re almost a full % point below historical average. The problem is, inflation is almost exactly in-line with historical trend now and unemployment is well below trend. And more importantly, we’re not seeing cost push inflation any more. There was a brief period in 2022 where growth was low and we had high inflation stemming from supply constraints, but supply chains are largely healed now and commodity prices have fallen substantially. So, stagflation doesn’t seem like the right term here. This is closer to a stagnation than a stagflation, but it’s not even a stagnation. It’s just kind of a…muddle through?More By This Author:The Outlook For Rate Cuts & The Risks To Markets Some Midweek Reading – Economic Tightness And Easing Demand Chart Of The Week: The Softening Labor Market