CPI and a Bear Market

Michael Rudd, CFA | President, CEO and Portfolio Manager

This morning, the US released inflation data that was not well received by the market. The US Consumer Price Index (CPI) has topped a 40-year high coming in at 8.6% for the year. While the number was not unexpected, what has spooked the market was the monthly rate of change in inflation, once food and energy costs have been removed. CPI is basically the change in prices of day-to-day goods. From the US Bureau of Labor and Statistics: “Prices are collected each month in 75 urban areas across the country from about 6,000 housing units and approximately 23,000 retail establishments (department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments)”. Food and Energy comprise just over 21.5% of the index and are quite volatile, so market participants often like to remove those components to get a cleaner view of broad inflation. Indeed, in the recent release, energy costs were up 34.6% and food was up 10.1% (year on year) while “All Other Items” were up 6.0%. Removing those volatile pieces can give us a different view of how inflation is creeping into other aspects of our lives, and it was this number that caused the markets to drop on the market open this morning.

Expectations were that month-on-month CPI (ex Food and Energy) would be the same or lower than last month, but it actually had gone higher. Markets immediately reacted and have priced in a more aggressive response from the US FOMC for next month’s meeting. Figure 1 presents monthly inflation over time and the recent acceleration is obvious.

The disappointing data has pushed the S&P 500 close to a top to bottom drop of -20%, which would label it a “bear” market. A number of markets are already there with NASDAQ through -20% last week and Italy crossing as well. Figure 2 presents a cross section of several markets for illustration.

“This means that” we should expect more volatility from financial markets as both central banks and investors work through higher inflation expectations. However, long-term investors can use this as an opportunity to position themselves in great quality companies. We have been quite active in adjusting the positioning in all of our mandates over the past several weeks.

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