Inflation has been public enemy No. 1 of the stock market for the past 16 months. But now that inflation pressures are rapidly subsiding, the outlook for a stock market rally into the summer is greatly improving.
Today, the U.S. Bureau of Labor Statistics released its April Consumer Price Index report, which is the most widely followed inflation report.
It showed that the headline inflation rate in the U.S. dropped again in April to 4.9%, below expectations for a reading of 5%.
Inflation has now dropped for 10 consecutive months, matching the longest losing streak for inflation in the past 100 years!
You read that right. While it may still feel like prices are high, the data says we are in the midst of the most powerful disinflation streak of the past century. Inflation is very clearly on track to revert back to its long-term averages within a few months.
As inflation falls, stocks are rising – especially inflation-sensitive tech stocks.
Year-to-date, the S&P 500 is up more than 7%. The tech-heavy Nasdaq Composite is up 17%.
This rally is not a head fake – it’s the start of a big breakout, mainly due to the expected sharp decline in inflation in the near future.
Bank Tightening Leads Inflation Collapse
Bank lending standards have proven to be a very reliable leading indicator of inflation trends over the past 25 years. During that time, these standards have been about six months ahead of inflation rates.
And when banks dramatically tighten lending conditions, inflation tends to collapse over the next six months. When banks loosen lending conditions, inflation tends to soar over the next six months.
Ever since Silicon Valley Bank failed in early March, banks across the U.S. have dramatically tightened their lending standards. The pace and magnitude of tightening we’ve seen in April and May has only been matched twice this century – during COVID and the 2008 financial crisis.
This record-level tightening in bank lending standards strongly suggests that inflation will keep crashing in the coming months.
Shelter Inflation’s Finally Rolling Over
At the same time, the biggest component of inflation – shelter – is finally starting to roll over. Leading indicators suggest it will come crashing down over the next 12 months.
Shelter CPI rose 8.1% in April, down from 8.2% in March. Sure, that is the tiniest of drops. But it is a drop nonetheless, and it is significant because it is the first drop that shelter CPI has registered in this economic cycle.
Data suggests this is just the first of many shelter CPI drops over the next year.
Over the past few years, Zillow’s (Z) Observed Rent Price Index – which tracks real-time rent prices across the U.S. – has proven to be a pretty reliable leading indicator of shelter CPI, with a lead of about 12 months.
That is, when Zillow’s Observed Rent Price Index moves higher, shelter CPI tends to move higher over the next 12 months, and vice versa.
Zillow’s Observed Rent Price Index peaked about 12 months ago at 17% growth. Since then, it has collapsed to 6%.
The shelter consumer price index () decreased from 8.2% to 8.1% in April. This could indicate that the shelter CPI will continue to decline sharply in the next year, reaching 5%, 4%, 3%, or even lower levels.
Shelter is the biggest weighting in CPI. If it collapses over the next 12 months, headline CPI will assuredly crash, too.
The Final Word
On the whole, the bulk of evidence strongly suggests that inflation will keep crashing – and perhaps even at an accelerated pace – over the next few months.
As inflation has crashed over the past few months, stocks have soared, particularly tech stocks.
And as it keeps crashing over the next few months, stocks will keep soaring, particularly tech stocks.
We think being bullish on tech stocks today will pay off in spades over the next few months.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.