28
Aug
2022

Signs that inflation may be waning

Scott Martindale  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Federal Reserve chairman Jay Powell sounded quite hawkish at his brief Jackson Hole speech on Friday, and investors were spooked. But keep in mind, he will be reacting to the inflation data as it comes. And although the CPI hit 40-year high of 9.1% YoY in June, I see plenty of signs that inflation is in retreat. Many commentators have been attempting to predict the future of inflation and the economy by making comparisons with prior periods of high inflation. But what makes today’s situation unique is the impact of artificial supply chain disruption due to forced lockdowns rather than economic forces. Thus, I believe the Fed has been trying to “buy time” to allow supply chains to mend by using hawkish rhetoric and creating as much demand destruction as possible – without overtly crushing the economy into recession (a la Paul Volcker). Here are some of the signs that inflationary pressures are receding:

  1. CPI began to flatten out in July after 16 straight months of increases, coming in at 8.5% YoY (after topping out at 9.1% in June).
     
  2. Business inventories have risen sharply (according to the St. Louis Fed), which implies disinflationary pressure on finished goods, and the important inventory/sales ratio is making its way back to pre-pandemic levels. Wholesale prices and import prices both came in better than predicted, and commodity prices, shipping rates, and home prices are all either stabilizing or falling.
     
  3. The Fed’s preferred inflation gauge – Personal Consumption Expenditures (PCE) Index excluding food and energy – has slowed each month since its February peak, falling from 5.3% to 4.7%.
     
  4. July PPI data fell 0.5%, which was the first decline in producer prices since pre-pandemic. Historically, large moves to negative PPI readings like this have led to significantly lower inflation over subsequent months.
     
  5. The New York Fed’s Global Supply Chain Pressure Index (GSCPI) has been falling rapidly since the start of the year.
     
  6. The St. Louis Fed’s 5-year Breakeven Inflation Rate has fallen to 2.73%, and the 5-year/5-year Forward Inflation Expectation Rate is only 2.41%. Also, the University of Michigan Inflation Expectations survey of consumers, median expected price change, are at 4.8% for the next 1 year and 2.9% for the next 5 years.
     
  7. Gold prices continue to languish due to the ultra-strong dollar and expectations for rising real interest rates (nominal rate minus inflation). Historically, gold thrives when inflation rises and real interest rates fall, leading to a weaker dollar, which makes gold attractive as a store of value. But there has been no rush among investors to hold gold.

Of course, Fed monetary policy can only impact demand; it has no impact on disrupted global supply chains. The Fed can only withdraw stimulus by unwinding QE (i.e., letting bonds on its balance sheet mature and/or selling some into the market) and raising interest rates to the “neutral rate.” In fact, I believe we are close to that elusive neutral rate, given how sensitive the highly leveraged US and global economies (consumers, businesses, and governments) have become to debt financing costs. Moreover, the Fed must ensure sufficient global supply of dollars in a world hungry for them (85% of foreign exchange transactions, 60% of foreign exchange reserves, and 50% of cross-border loans and international debt are in US dollars.) All ears will be on the September FOMC meeting on 9/21, when the Fed may announce a final rate hike followed by language indicating that it will “wait & see” how conditions develop going forward (in spite of the tone of Powell's written speech on Friday). 

Author: smartindale / Tag: inflation, federal reserve, CPI, PPI, GSCPI, FOMC, stocks, neutral rate, interest rates / 0 Comments
23
Aug
2022

It all rides on inflation and the Fed, but signals are looking bullish

Scott Martindale  by Scott Martindale
  President & CEO, Sabrient Systems LLC

So far this year, the Federal Reserve has been removing liquidity from the markets via rate hikes and quantitative tightening, hence the 1H22 crash. But stocks have rallied strongly since the mid-June lows on the growing belief that the Fed will make one more rate hike in September and then pause ahead of the midterm elections – and perhaps even start cutting rates in the New Year. However, many others remain adamant that the Fed is committed to keep raising rates until it is clear that inflation is under control.

I remain of the belief that the hyper-financialization of the US and global economies means that rising rates could cripple debt-addicted businesses and governments (including our own federal government!), and the housing market (which is critical for a healthy consumer) depends upon mortgage rates stabilizing soon. And as the dollar further strengthens (it just went above parity with the Euro!) given the relatively higher interest rates paid by the US, some emerging market economies with dollar-denominated debt may be forced to default. In other words, today’s financial system simply can’t handle much higher rates – which suggests the Fed may already be at or near the elusive “neutral rate” and will ultimately choose to live with elevated inflation.

Earnings season has turned out better than expected, even though profit margins have been challenged by inflationary pressures. Still, at an estimate of about 12.4% (down from a record 12.8% in Q1), profit margins remain well above the 5-year average of 10.8%, according to FactSet. After a long period of low and falling inflation, massive monetary and fiscal stimulus combined with extreme supply chain disruptions (including lockdowns in manufacturing centers, labor shortages, logistics bottlenecks, and elevated energy and labor costs) sent inflation soaring. This cut into profit margins (albeit less than many predicted), as did falling US labor force productivity, which has seen its worst drop so far this year since 1948, according to DataTrek.

But now, inflation is showing signs of retreating due to both demand destruction and mending supply chains (including lower energy, commodity, and shipping costs), as well as a strong dollar. U.S. business inventories are up such that the important inventory/sales ratio is back to near pre-pandemic levels, which is disinflationary. Moreover, productivity-enhancing technologies continue to proliferate along with other disinflationary structural trends, which I believe will reverse the troublesome recent trend in labor productivity and help to contain costs and boost profitability – leading to rising corporate earnings and real wages, which together reflect a healthy and sustainable economy and stock market. All of this is of critical importance because the direction of interest rates and stock prices largely depend upon the direction of inflation and the Fed’s reaction to it.

In addition, positive catalysts like an end to Russia’s war on Ukraine or China’s COVID lockdowns, and/or a Republican sweep in November that brings greater support for domestic oil & gas production, all would be expected to hasten improvement in supply chains and have an immediate impact on inflation. In other words, compared to prior inflationary periods in history, it seems to me that there is a lot more potential on the supply side of the equation to alleviate inflation rather relying primarily on Fed policy to depress the demand side.

So, what comes next? I suggested in my late-June post that there were numerous signs of a market capitulation, and indeed the market has roared back. The big questions are whether we have seen the lows for the year and whether we will see new highs; whether this has been simply a strong bear-market rally or the start of a new bull market. I believe the current pullback is simply a normal reaction to the extremely overbought technical conditions after such a strong (nearly monotonic) rally. It simply ran into a brick wall at the convergence of the May highs and the 200-day moving average, mostly due to buyer exhaustion. In fact, some traders have observed that the S&P 500 historically has never fallen to new lows after retracing more than 50% of its bear-market losses, as it has done. I talk more about this in my full post.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 5 of the top 6 scorers being cyclical sectors. In addition, the technical picture looks short-term bearish but longer term bullish, and our sector rotation model has taken on a neutral posture (at least until the S&P 500 retakes its 200-day moving average). I also offer up a political comment that you might want to ponder. Read on…

Author: smartindale / Tag: ETF, sectors, inflation, CPI, interest rates, gold, supply chain, federal reserve, Baker’s Dozen, S&P 500, Value, Growth, quality, GARP, SectorCast, technology, financials, healthcare, energy, Consumer, industrials, telecom, utilities, materials, SPY, VIX, IYF, iyw, IYJ, IYZ, IYC, IYK, IYH, IDU, IYM, IYE, FCG, FTRI, VDE, FXN, FFTY, IEO, WBIF, WGRO, ITB, SLX, QMOM, AFSM, AMOM, WBIL, AVUV, SENT, TINY, DFRA / 0 Comments
01
Aug
2022

Video Overview of New Sabrient Portfolios

Sabrient has just posted a 15-minute video by CEO Scott Martindale providing an introduction/overview of the new Q3 2022 Baker’s Dozen, which launched on 7/20, and Forward Looking Value, which launched on 7/15, as selected by David Brown and his analyst team. Scott also describes our Dividend portfolio (reflecting growth, value, quality, with 4% yield) and Small Cap Growth. This video is essentially “Part 2” to the more macro-oriented video posted on 7/13.

Video link.

Author: sandra / Tag: Baker's Dozen, Forward Looking Value, dividend, Small Cap Growth, Sabrient Portfolios / 0 Comments