Inflation Hasn’t Yet Peaked; Thoughts on Retail Sales and Financials

CONSUMER PRICE INDEX UP 8.5%: On Tuesday April 12^th, the Bureau of Labor Statistics (BLS) announced that the Consumer Price Index (CPI) increased 8.5% y/y and that Core CPI, which excludes food and energy, increased 6.5% y/y.  

While some economists like to use Core CPI to measure how inflation is impacting consumer demand, we believe food and energy are significant components of consumers’ lifestyles. The food-at-home index has risen 10% y/y while the food-away- from-home index has risen 6.9% y/y. Energy is up 32%y/y in the same timeframe. Gas prices are up 18.3% m/m and 48% y/y. Rents, which typically lag the housing market by about a year, are up 4.5% y/y… and we expect them to climb higher as the increase in housing prices flows through to renters. The Dallas Fed forecasts average rents will be up 6.9% by 2023 from the 4.5% levels reported by the BLS. 

PRODUCER PRICE INDEX UP 11.2% (!): On Wednesday April 13th, the BLS released the Producer Price Index (PPI) and Core PPI; they were up 11.2% y/y and 7.0% y/y, respectively. Service inflation rose 8.7% y/y and goods increased 15.7% y/y. Services matter a lot more than goods because it impacts consumption, inflation and income. Services spending is 2/3rd of total consumption, 4/5th of employment, and it is 60% of the CPI. The leading contributor to PPI was a 5.7% increase in prices for final-demand energy. Diesel prices jumped 20.4%. In contrast, the prices for beef, veal, natural gas and cold-rolled steel all declined in March.  

The Media Speculated That We Had Seen Peak Inflation. They appear to be wrong. Even if they are right, inflation is still higher than it has been since 1981.  

The Fed will need to continue to tighten.  

The bond market is pricing in 8 hikes this year and 4 next year. We believe the Fed will increase the Fed Funds Rate by 50 bps in May, with another 50 bps in June. Thereafter, we expect the Fed to watch the data closely… as will we. Anything can happen in the span of 12-18 months,  

so the longer-term path remains more uncertain. We still believe there will not be a recession this year, but we will keep a strong eye on the data and the Fed going into 2023.  

The chart below is an updated look at the current probabilities of the next interest rate hikes for the rest of the Fed meetings scheduled for this year based on bond market pricing. The chart is showing a 94.0% probability that the Fed will raise 50 bps to 75-100 bps cumulative on the year. 

Chart 1: Probabilities of Cumulative Rate Hike Schedule¹ 

RETAIL SALES REMAIN STRONG: On Thursday, we learned that Core Retail Sales were up 6.9% y/y. We continue to have confidence in the consumer, whose spending on goods, and especially on services (e.g., travel, tourism), should continue to strengthen post-pandemic.   

BANK EARNINGS MIXED, BUT OUTLOOK REMAINS STRONG: Rising interest rates typically favor financials in general and banks in particular; the rising rate environment allows companies to borrow at lower rates and lend or invest at higher rates, improving profitability. As of Thursday morning, the major banks listed in Chart 2 had reported earnings. 

We see earnings as mixed-to-slightly-better-than-expected. Company comments so far are also mixed due to uncertainty driven by geopolitical risk, inflation and ongoing disruptions to supply chains. We remain constructive on banks, noting that a 50 bps increase in the Fed Funds rate projects a 16% increase in bank earnings.   

Notably, J.P. Morgan (JPM) announced a $30 billion stock buyback, typically a signal of confidence in capital position and ability to return capital to shareholders. We view this as a positive sign. 

Chart 2: Bank Earnings Q1 FY22² 

Closing Remarks: 

We continue to believe that a barbell approach, balanced between growth and value, should perform well in this environment. We remain overweight energy, materials, industrials, discretionary and financials and will look for opportunities in high quality growth/technology, where we continue to be underweight.  

Stephanie Link: CNBC TV Schedule 

Sources

1. Factset (chart)
2. Factset (chart)

Disclosures 

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.