CPI data show cooling but stubborn inflation … supply chain inflation could face upward pressure … what are bonds telling us? … ignoring the 10-2 Spread
This morning, we learned that January’s Consumer Price Index (CPI) reading showed continued cooling on the inflation front.However, the rate of that cooling is leveling off.The CPI showed that inflation climbed 6.4% from January of last year. That’s down from December’s reading of 6.5% and marks the seventh straight month of declines since peaking in June at 9.1%.Despite cooling, the number came in hotter than experts expected. Economists surveyed by The Wall Street Journal had called for overall consumer prices to increase only 6.2% in January.On a month-over-month basis, CPI climbed 0.5%. That was more than the 0.4% estimate from WSJ economists and the largest increase in three months.We also received a government revision of December’s consumer prices that showed prices rose 0.1% that month rather than cooled 0.1%.Finally, the “core” rate of inflation, that excludes food and energy, climbed 0.4%, also above the 0.3% estimate.That’s a lot of “hotter than expected” numbers – did Wall Street run for cover?Well, it was interesting…All three indexes wobbled momentarily, but then surged. As one point, the Nasdaq was flirting with a 1% gain before bleeding off.It appears the bullish spin on this CPI report ran out of steam as the reality that the Fed isn’t going to find these numbers “pause worthy” set in.As I write early-afternoon, all three indexes are in the red with the Dow down the most at -0.75%.
Meanwhile, yesterday, we received news about the potential for resurgent inflation in supply chains
Over the past six months, we’ve made progress on some of the variables that have led to higher supply chain costs.For example, ocean freight rates have dropped and the cost of transportation fuel has declined alongside falling crude prices.But bloated inventories, based on a lack of consumer demand, are putting upward pressure on warehouse rates.From CNBC:
Full warehouses and distribution centers have some shippers holding their products in containers on chassis, but this has them incurring charges which are passed on to the consumer.Shippers are given an allotted amount of free time during which they are not charged for holding a container, but once those days expire, per diem charges (late container charges that are charged for containers out of port) start to be charged.
The article interviewed Paul Brashier, a logistics expert from ITS Logistics who points toward “per diem” charges that accrue to shippers who can’t move their products into (full) warehouses.Back to CNBC for the impact on consumer prices later this year:
[Brashier] predicts that per diem charges are going to surge in the second and third quarters of this year.“These are on top of charges for warehousing which are still at historic highs,” Brashier said. “Late fees and warehouse fees are passed onto the consumer, which is why we are not seeing products fall as much as they should” …For shippers with inventory imbalances, Brashier says these charges could cost shippers tens of millions of dollars per quarter. Brashier warns these charges, on top of weaker consumer demand will ripple through earnings.
The article goes on to highlight that national storage pricing is up 1.4% month-over-month and 10.6% year-over-year, according to WarehouseQuote.
Speaking of earnings, we’re nearly done with Q4 earnings season and bulls have the edge
To be clear, they don’t have the edge based on overall performance.As expected, it’s been a relatively weak earning season. To illustrate, we turn to FactSet, which is the go-to earnings data analytics group used by the pros.As of last Friday, with nearly 70% of companies in the S&P having reported earnings, FactSet reports 69% have reported actual EPS above the mean EPS estimate. While that sounds good, it’s below the five-year average of 77% and the 10-year average of 73%.So, why does the edge go to the bulls?Because bullish sentiment is resulting in bigger gains for companies that beat earnings and smaller punishments for companies that miss.To illustrate, let’s zero in on the “punishments” for companies that miss earnings.Here’s FactSet:
Companies that have reported negative earnings surprises for Q4 2022 have seen an average price decrease of -0.4% two days before the earnings release through two days after the earnings release.This percentage decline is smaller than the 5-year average price decrease of -2.2% during this same window for companies reporting negative earnings surprises.
Why is this happening?Is Wall Street looking past less-than-wonderful earnings because of rosy forward-looking guidance?Remember, Wall Street is in the business of pricing “what’s coming” rather than “what’s here.” So, optimistic forward-looking earnings expectations might offset less-than-wonderful current earnings.The data suggest this is not what’s happening.Back to FactSet:
Why is the market rewarding positive earnings surprises slightly more than average and punishing negative EPS surprises much less than average?It is likely not related to the earnings outlooks provided by companies and analysts during the Q4 earnings season for Q1 2023, which have been more negative than average.In terms of earnings guidance, 82% of the S&P 500 companies (58 out of 71) that have issued EPS guidance for Q1 2023 have issued negative guidance.This percentage is well above the 5-year average of 59% and the 10-year average of 67%.
It appears we’re seeing sentiment-based bullishness, not fundamentals-based bullishness. It’s the same sentiment that briefly led the market to be up this morning despite hotter-than-expected inflation data.Meanwhile, the bond market is suggesting stock investors should be careful.
Bond traders – “the smart money” – are signaling caution
Historically, bond traders have a better record of calling future market shifts and conditions than stock traders.The common explanation for this is that bonds are more sensitive to interest rate fluctuations and tiny changes in the broader economic landscape than stocks. So, bond traders have developed a more accurate ability to read the tea leaves.So, what’s happening in the bond market?Well, since hitting a recent local bottom of 3.33% on the last day of January, the 10-year Treasury yield has been climbing. Because yields and price have an inverse relationship, this means bond traders have been selling, pushing prices lower.Since January 31st, the 10-year Treasury yield has climbed from 3.33% to nearly 3.77% as I write.
A helpful visual comes from TLT, which is the iShares 20+ Treasury Bond ETF
It’s a simple way to get a bead on the bond market.Below, we see that TLT has been rallying hard since last fall. The biggest test for TLT came at the beginning of February, when it encountered its 200-day moving average (MA).We profiled moving averages in the Digest last week.In short, they service as important psychological lines-in-the-sand for Wall Street traders.When an asset can break the “resistance” of a long-term moving average, or when it crashes through the “support” of such a moving average, it serves an important sign of strength or weakness.At the beginning of February, TLT finally pushed through its 200-day MA. But it couldn’t hold this bullish breakout. It crashed back through, as you can see below.
This interplay between TLT’s price and its 200-day MA will be important to watch in the coming days.If TLT can turn resistance into support, it could signify a bullish shift in the bond market. But until that happens, the message we’re receiving is “caution.”
Related to bonds, keep your eye on what’s happening with the “10-2 Spread”
In healthy, normal markets, a bond yield curve moves from “lower left to upper right.” This simply means that investors require a higher yield in exchange for lending their money for longer periods of time.A curve that’s flat or “upper left to lower right” reflects an ailing economy – or fears of an ailing economy.And when short-term yields (think the 2-year Treasury bond yield) move higher than long-term yields (think the 10-year Treasury bond yield), we get a “yield curve inversion.”To monitor this, we can look at a single chart that shows us the spread between the 10-year Treasury yield and the 2-year Treasury yield, something called the “10-2 Spread.”A negative 10-2 Spread (meaning an inversion) has predicted every recession from 1955 to 2018.To be fair, we have seen inverted yield curves that do not correspond with recessions.Today, the 10-2 Spread has been inverted since July of last year. It’s one of the longest stretches of inversion in history.Plus, the level comes in at -0.85%, which is not too far from the October 2, 1981 low of -96.8% when then-Federal-Reserve-Chairman Paul Volcker battled runaway inflation.
But here again, bullish sentiment is putting a positive spin on this warning sign
Rather than focusing on this 10-2 Spread as being a red flag for upcoming economic conditions, the headlines are shrugging it off.Here are a few, all from within the last week.From Forbes:“For 50 Years, This Phenomenon Has Reliably Predicted Recessions. Not Anymore.”From Axios:“The yield curve may be wrong when it comes to predicting recession”From Seeking Alpha:“Here is Why You Should Ignore the Inverted Yield Curve”A second from Seeking Alpha:“Who’s Afraid of An Inverted Yield Curve?”
In short, we’re seeing a great deal of “but this time it’s different!”
Perhaps it is.Or perhaps we’re just watching a moment in time when bulls are back in charge, willfully ignoring a near-historic 10-2 Spread, weak earnings and depressed forward guidance, stubborn inflation, and a Federal Reserve that’s explicitly saying the work isn’t yet done.We’ll keep you updated.Have a good evening,Jeff Remsburg
