Core Goods Inflation
Everybody is focused on inflation because it is impacting their pocketbooks. We are looking at it from a market standpoint and the reason is because inflation is driving the Federal Reserve’s $9 trillion decision. Inflation came out on Friday at 8.6%, which is much higher than we expected. That beat the previous month’s reading of 8.3%. It really wasn’t just inflation though because we expected inflation to be high. What we were really looking for was a peak. It is going to be hard for the market to bottom until inflation peaks because it’s hard for the market that set any kind of expectation around the Fed’s decisions and rates without knowing where inflation will stop. The fact that it continued to rise from 8.3% to 8.6% was a bit concerning. We saw the market react very negatively to that news and we are continuing to see that today. Where did inflation come from? If you look under the hood, there are a few things that contributed. On a chart shown in this episode, sorted by year-over-year change, it shows transportation was up 19% with food and beverage up 9.73%. Housing was also up 6.9% year-over-year, which is actually cooling down from where we saw the housing market last year. Things must peak before they start coming down. Under the hood there are some positive areas such as the price of used cars and lumber is coming down. Maybe we’re starting to see the early signs of inflation potentially starting to decrease. What makes up inflation? Twenty percent of inflation is food and energy which is what we see on day-to-day basis. Twenty percent is core goods which is cars, refrigerators, and such. The other 60% is services. That core goods inflation that we are watching closely, we think could come down as we get through the summer months. That is what the Fed is watching as well. The Fed doesn’t pay as much attention to the food and energy because it’s so volatile from day-to-day and month-to-month. We got a disappointing report on Friday, but also some potential good news. How the Fed reacts will be very important.
Inflation is a problem and we’re seeing a lot of negative headlines right now. However, one positive thing we want to point out is that corporate earnings, while they’re slowing, they’re not contracting. There have been recent lower earnings expectations announced, which has increased market concerns, but it’s important to point out that the consensus earnings per share of the S&P 500 Index is still estimated to grow as much as 10% this year. If the US economy grows the rest of the year, which we expect, then earnings should support stock prices in the second half of the year. It will continue to be choppy, no doubt about that, but corporate earnings are still growing. While the growth pace is slower than previous years, earnings are still not expected to decline.
The Federal Reserve
What is the $9 trillion decision? The Fed is obviously trying to fight inflation, and one way they are doing that is with interest rates. They meet on Wednesday of this week, and we are expecting to get at least a 50-basis point rate hike as well as another one in July. The big question is, will they stay at the 50-basis point expectation, or will we get a surprise and it be higher? That is something that we will have to keep an eye on along with the inflation numbers that recently came out. On top of that, the long-awaited quantitative tightening will be starting this month. The Fed will begin letting their bonds mature instead of reinvesting the cash and putting money into the economy. As bonds mature, they are planning to shrink their balance sheet down from $9 trillion, which is around 40% of GDP to try to get it closer to 20%. They are going to start this by letting $47.5 billion run off their balance sheet until September. That is supposed to double for the rest of the year and for the foreseeable future. We are now in play with two different metrics, one being rate hikes and the other being quantitative tightening. We will be watching this closely to see where we go from here.
We experienced a lot of turbulence in the overall markets last week, specifically on Thursday and Friday, with all 11 sectors being down both trading days. The S&P 500 closed on Friday priced at 3,900 giving us a new resistance level of 3,950 and a new support level of 3,850. We saw the 50-day moving average come down a little bit as well and is currently sitting at 4,198. The number to focus on this week, is that support line price of 3,850. It is a very important one to keep an eye on as the week unfolds.
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