Is Inflation Ready to Roll Over?

The typically mundane monthly CPI reports have become like the super bowl for the stock market each month as of late. In past years, the monthly reports wouldn’t have even been mentioned on the day they were announced. Times have changed. Now there are days of buildup on CNBC as pundits come on air and tell everyone where they think the numbers will land, and how the Federal Reserve and the market will react. The CPI readings have the power to move the market in a huge way because the market sees them as an indicator of whether the Federal Reserve will continue raising interest rates and by how much. The market desperately wants the FOMC to stop or slow raising rates. It is primed for a massive run higher once the FOMC signals they are done or almost done doing so.

The problem is CPI has been stubborn. Very stubborn. Stubborn like my daughter spreading the broccoli around the plate to make it look like she ate some of it. The June CPI data that was released on July 12th, 2022 came in below analyst expectations and the market rallied 15% in the next 4 weeks! Similarly, the August CPI data that was released on September 13th, 2022 came in above analyst expectations and the market promptly fell 13% over the next 4 weeks. CPI is turning out to be stickier than the market and the Fed had anticipated. But is that about to change? The answer to that question is important. The market will likely make a significant move higher when CPI begins to meaningfully decline; as that will be the signal for the Fed that inflation is easing permanently, and the effects of the pandemic on the market will be in the rearview.

Used Cars Leading CPI Indicator?

Recently, there are some indicators that inflation is actually beginning to roll over, but that data has not been reflected in the CPI readings yet. For instance, used car prices are 5% of the CPI formula. Not a huge factor, but meaningful and indicative of other factors in the formula. The most recent CPI data showed used car prices at +7.2% compared to a year ago (YoY). However, the Manheim Index, which measures the prices that used car dealers pay for cars at auction, was down over 10% YoY. See the chart below.

The dark line is CPI Used Cars. The light line is the Manheim Index. You can see the lines historically follow each other fairly closely. The Manheim Index commonly leads the CPI index higher, while also leading the way lower. There is a massive divergence in prices currently and history tells us that the CPI Index typically catches up with the Manheim Index, which would lead us to believe the CPI Used Car index may be much lower soon.

Supply Chain Woes

See the recent tweet by @LizAnnSonders regarding the stress on the supply chain.

Many economists believe that a large part of the inflation issue was supply chain related. This means the demand for goods was strong, but the supply of the goods was low, which in turn caused prices to rise. Now that the stress on the supply chain seems to be letting up, this also leads us to believe that inflation should start coming down in the near future. In our view, this is a best-case scenario when it comes to removing inflation from the economy. Another way to bring down inflation would be to decrease demand, but that would have a negative effect on corporate earnings. Increasing available supply helps keep corporate earnings strong, as well as reducing the average prices of goods being sold.

Inflation is a complex issue and these are only a few of the many factors that are involved. We seem, at least, to be moving in the right direction.

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