Are we at peak inflation? … how Russia and China are impacting your wallet … the labor market isn’t helping inflation … what about yesterday’s rally?
When you read “inflation,” what probably comes to mind is “high prices.”
At least, that’s my association.
But actually, inflation simply measures the percentage change in the price of an item or a basket of items.
This means that two things can be true at once: Inflation can drop substantially, yet you can also be paying nosebleed prices as that happens.
I make the distinction because we’re beginning to see whispers of “peak inflation.” In fact, it’s more than a whisper.
I’m noticing an increasing number of headlines that proclaim some version of this. Here are three such examples from just the last few days:
So, great news, right?
Well, yes and no.
If we have reached peak inflation, fantastic. Better to be on the far side of it, for sure.
On the other hand, even if we’ve reached peak inflation, that doesn’t mean we’re out of the danger zone. That’s because you can have zero inflation, yet incredibly high prices that hurt shoppers and the economy.
***To illustrate, let’s say your pack of six chicken breasts cost you $14 about 12 months ago
Today, it costs $19. That’s 36% inflation over 12 months. That’s roughly what I think I’ve seen in my own shopping experience here in Los Angeles.
Now, the latest Consumer Price Index report found that on a month-over-month basis, prices rose 1.2% in March.
But let’s say that in the next report, inflation miraculously drops to just 0.2%!
So, not only are we beyond peak inflation, month-over-month inflation has been gutted, dropping from 1.2% all the way down to just 0.2%.
We’ve done it! The long inflation nightmare is over! Your wallet can breathe a sigh of relief!
Well, yes and no.
Yes, it’s awesome that month-over-month inflation is down so much. But no, it’s not good in that you’re still paying nosebleed prices for your chicken.
In fact, by the numbers, your $19 chicken got 0.2% more expensive – even though inflation has all but disappeared.
The question today is how long the U.S. consumer will remain healthy in this new high-cost environment, regardless of if we’re at peak inflation or not.
Yesterday, Fed Chair Powell suggested the U.S consumer is incredibly healthy.
Okay, well, great, but if that’s true, the Catch-22 is that all these healthy consumers will continue to buy goods with elevated prices. And according to Econ 101, that means prices will continue to see upward pricing pressure.
If we don’t want consumer-based inflation, we need a consumer unwilling/unable to pay higher prices. But that would likely mirror an “unhealthy” economy.
Pick your poison.
Either way, this does bring up a question about what’s driving all of these flush consumers.
***Dislocations in the domestic job market mean there are still upward pressures on wages, which is another inflationary influence
On Tuesday, the Labor Department reported a seasonally adjusted 11.5 million job openings in March. That’s an increase from 11.3 million in February.
At the same time, there’s massive demand for these workers.
From The Wall Street Journal:
Separate private-sector estimates showed that demand for labor remained red-hot through April. Jobs site ZipRecruiter said employers had about 11 million job openings last month.
The Chief Economist at ZipRecruiter calls this “the greatest job seekers’ market of all time.”
As you might imagine, the greatest job seekers’ market of all time means that employers are having to shell out more bucks in the hiring process.
Translation – wage inflation.
From Reuters on Tuesday:
The Labor Department’s Job Openings and Labor Turnover Survey, or JOLTS report, on Tuesday also showed a record 4.5 million people voluntarily quit their jobs, underscoring the growing wage pressures.
The government reported last week that compensation for American workers notched its largest increase in more than three decades in the first quarter.
Interestingly, Fed Chair Powell downplayed this as a wage spiral in his comments yesterday:
We don’t see a wage price spiral, [but] we see that companies have the ability to raise prices.
That’s an interesting description for the largest wage increase in three decades.
***Meanwhile, the Russia/China influence on U.S. inflation is poised to worsen
Let’s forget domestic consumer prices for a moment and look bigger picture.
In recent days, we’ve learned that the European Union appears to be moving forward with plans to end its reliance on Russian oil.
From yesterday in MarketWatch:
The European Commission, the executive arm of the EU, on Wednesday put forward new sanctions against the Kremlin, which will include a six-month phase out of Russian crude imports…
“Let us be clear: it will not be easy,” European Commission President Ursula von der Leyen said during a speech at the European Parliament on Wednesday.
“Some member states are strongly dependent on Russian oil. But we simply have to work on it. We now propose a ban on Russian oil. This will be a complete import ban on all Russian oil, seaborne and pipeline, crude and refined.”
And what did already-high oil prices do in response?
They popped about 3% higher. They’re up again today as I write.
A European ban on Russian oil will only add pressure to oil’s price… which impacts your wallet… which impacts your buying behavior… which impacts the U.S. economy… which impacts corporate earnings… which impacts stock prices.
Now, yes, this might be temporarily offset by China and its asphyxiating Covid lockdowns. As I write, China’s “zero Covid” policy remains in place and is crushing economic output and oil demand.
But you have to think Beijing’s iron fist will loosen at some point. And when Chinese oil demand ramps back up, coupled with the EU embargo on Russian oil, that’s a highly inflationary combo.
***Adding to inflationary pressures, we still haven’t seen the full impact of the Russia/Ukraine war on global food prices
Remember, Ukraine is the “bread basket” of Europe.
As we’ve noted before in the Digest, Ukraine accounts for more than 10% of the global wheat market. Throw in Russia, and that share jumps to more than 30%.
It’s not just wheat. There’s also corn and barley, which are important in feeding livestock. Together, Ukraine and Russia make up just under 30% of the world’s barley supply.
Then there’s sunflower oil, which is one of the world’s main vegetable oils used for cooking. Ukraine and Russia make up 80% of the global supply.
Big picture, it’s estimated that Ukraine and Russia alone account for 12% of the calories that the world consumes.
With these calories now not making it to market, it’s having a substantial impact on supply, and by extension, price.
But keep in mind, there’s a lag to seeing the full impact of this at the grocery store. Especially so if Ukrainian farmers miss the spring planting season.
Here’s Bloomberg on this note:
The food shock in Ukraine looks devastating.
Grain and sunflower oil in storage from last year’s harvest can’t be shipped because of fighting and port closures.
Shelling and fuel shortages may interfere with spring planting and fertilizer farmers need to apply to the winter wheat crop as it emerges from dormancy.
Infrastructure damage, labor shortages and continuing conflict could also compromise the summer harvest and transportation of whatever is produced.
Sanctions and disruption of Black Sea shipping routes also will limit Russian exports, beyond grain.
Russia, a key global supplier of fertilizers, earlier this month instructed producers to halt exports. Russian ally Belarus, another leading fertilizer source, is also being hit with sanctions.
As evidence of this food shock and its ramifications, yesterday, wheat futures jumped 3% as India is reported to be weighing restrictions on its exports. They’re up another 2.5% today.
Meanwhile, yesterday, a different Bloomberg article suggested shoppers should prepare for even higher beef costs:
Beef will be getting even more expensive at U.S. grocery stores in the months ahead, according to one of the country’s biggest meatpackers.
National Beef Co., controlled by the Brazilian giant Marfrig Global Foods, sees relatively stable margins in the next two quarters, according to Tim Klein, who heads Marfrig’s U.S. operations.
That means even though their costs to buy cattle are increasing, the company will ultimately be able to pass that on to consumers in the form of pricier steaks and burgers.
Again, this reflects the Catch-22 of the moment…
If U.S. consumers truly are healthy, they’ll pay more for higher beef costs. But that’s going to mean higher inflation.
Eventually, when the U.S. consumer is not healthy and won’t pay up, that may help bring down inflation. But such a drop may also mirror a similar drop in broad economic activity – e.g. a recession.
***So, let’s put all of this together
Let’s assume we’re near or at peak inflation. Okay, great. But we shouldn’t expect that to mean prices will soon be dropping.
Meanwhile, the EU’s embargo on Russian oil is likely to make prices at the pump more expensive. So too could Chinese demand once Beijing eases lockdown restrictions.
On top of that, U.S. workers have all the power today. The result is employers are having to pay out higher salaries.
More money in the American consumer’s pocket means he/she will pay higher prices (like we just saw with the beef example).
Persistent, higher prices mean the Fed could feel added pressure to maintain hawkish policy, which increases the risk of hurting the economy.
The way out of this is the proverbial “soft landing,” in which rates rise enough to quell inflation but not so much that it hurts the economy.
That could happen – it’s tough to do, but certainly possible. We’re cheering for such a resolution, but the wise investor plans for all potential outcomes, not just the most optimistic one.
***So, what then of yesterday’s rally? Does that contradict all of the headwinds we covered above and show that the market is ready to soar?
According to AAII, as of last week, investors were the most bearish they’ve been since the great financial crisis in 2009.
This type of extraordinary sentiment leads to reversals. The market simply can’t remain in a state of extreme bearishness (or bullishness) for too long. At some point, the stretched rubber band releases and zooms across the room in the opposite direction.
We’ve been overdue for a stock market rally thanks to the historic pessimism. Frankly, I’m more surprised to see today’s weakness than yesterday’s rally. I thought we’d get more gains out of it.
Then again, there are reasons for this historic pessimism, some of which we profiled today. And those reasons don’t go away even though beaten-down bulls finally regain some control from the bears for a spell.
“Jeff, you’re incredibly depressing. It’s bringing me down.”
Let’s not miscommunicate.
I’m not saying the market is going to fall off a cliff, even with today’s losses.
I am saying that I find a more cautious forecast appropriate. Especially compared to the forecast from analysts we saw yesterday, which suggests 26% gains for the S&P over the next 12 months.
Now, as we’ll pick up tomorrow, there are certain stocks that could post those kinds of gains in the coming quarters – in fact, possibly far bigger gains.
But as for the average S&P stock? Lots of headwinds today.
Have a good evening,
Jeff Remsburg
