2022 Theme: Shelter & Inflation - Have We Reached The Tipping Point?
We couldn't let the bizarre reaction to the early October inflation print pass without mentioning:
What happened
And why it matters
Long story short, inflation was uncomfortably high and also above expectations.
Plus ça change.....
Core inflation (so without energy and food) was 0.6% for the month (6.6% over the last year) and rising at its fastest pace since 1982....
This is not a great chart, no matter who you are:
All of the above will have been very unwelcome in many quarters of the American economy and society - especially perhaps, in the White House.
This news, unsurprisingly, caused global financial markets to sell off viciously. When the data was released the US stock market wasn't even open yet but futures immediately plunged and when 9:30 finally did roll around the S&P 500 was down 2%+ in a matter of seconds.
Other risk assets were similarly affected.
But then, about 15 minutes after that, markets rallied - equally hard.
Here is how this looked for the Dow:
This is pretty unusual!
To put it in perspective, going all the way back to the 1980s, there have only been 9 other days where the S&P 500 was down 2%+ intraday and finished the day up over 2%.
To give you a flavor of when these types of jumps occur, five of those were in 2008....
What is going on then?
The easy conclusion might be that, as usual, predicting what markets will do is very hard and over the short term, nearly impossible and so why bother?
That is likely correct but this episode is also interesting to think about for two reasons:
How markets react can be revealing about the current investor outlook.
It also underlines - yet again - just how tough investing can be. If you knew the data ahead of time (which would have been illegal) you would have likely bet the farm that the market would have sold off HARD. And the end result would be that you might have lost the farm....
As ever, keep an eye on the unofficial Pebble investing motto: be open minded, stay humble and let's be careful out there.
But the broader point is that we are getting to a point where sentiment is very bearish. War, winter, climate change, skyrocketing costs and interest rates etc etc.
Everyone is feeling pretty bummed out and that means they are very negative in terms of their positioning, not just with their opinion but also with their money.
The consequences of this, however, is if everyone is leaning one way then any sort of new information the other way will cause a rapid stampede in that direction causing a lurch upwards. Or that is the theory.
But our point here is not to try and get you to catch these waves. To the contrary, we want to stress that trying to do so is a mug's game and that is half the story here. But watching this unfold can reveal what people are hoping for and also could lead to a very rapid reversal if they are disappointed.
In the case of the above, CPI data point people are clearly hunting for reasons to be optimistic.
That is because they expect inflation to come down going forward.
More specifically, there is speculation that the majority of the reason for the negative data point is that the cost of shelter is rising. Shelter or housing cost is the single largest component in the CPI basket (around a third), as we have mentioned before.
And it also has a lag.
So adding those two factors together a lot of investors, upon diving into the CPI details, realized that if you strip out the lagging shelter component (0.7%) then the CPI would have been much less alarming.
In fact, if we exclude shelter, overall prices would have risen a more far less worrying 0.2%, and core prices by 0.5% in September.
This briefest glimmer of hope caused the monster rally with near historic proportions.
This isn't to say that the reason for this market performance was correct. It likely wasn't, if you strip out energy, food AND shelter - which is a lot haha - you are still left with prices rising by 6.7% over the last year.
No, the point is investors are looking for a reason for things to improve.
And they may get it. Just this Friday the Wall Street Journal reported that the Federal Reserve was "likely to debate then whether and how to signal plans to approve a smaller increase in December."
0.75% and 0.50% perhaps in December might seem small but it was largely responsible for a 2%+ move in the S&P 500 and this could well continue in the weeks ahead. People will front-run the Federal Reserve in the same way that they try to front-run a high inflation print.
They might be wrong and markets could quickly reverse and crush them but that fate might not stop them from trying!
So be mindful about the potential for another significant jump in risk assets before the end of the year. The S&P 500 went from 3,637 on June 17th to a rather incredible 4,325 by August 16th. This was quite a two month swing, now totally obliterated as we suggested might occur.
For tax purposes, alone it might be helpful and worth thinking about. Or perhaps you might like to reorganize your portfolio for the most likely scenarios in 2023.
We will cover some 2023 possibilities in future editions, so stay tuned.
Finally, this doesn't mean inflation is defeated but it could be that we simply don't care. As we mention above, we already witnessed one mind bending rally on little real information this past summer and, unlike June, at least now we have raised rates sufficiently to meaningfully impact the economy.
Whether it has been enough (or will be enough by the end of year) is another big question and one we will return to in the weeks ahead.
For now, be prepared and thoughtful about another strong and bizarre few weeks where financial markets could do well into yet another 0.75% rate hike by the most important central bank in the world.
It is wild out there and not just in financial markets...
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