October’s CPI and the Inflation Wall of Worry

Throughout this year’s maddening inflation, we have held the basic premise that sentiment surrounding inflation, rather than the fast-rising prices themselves, is the primary drag on stocks. This is always a hard thing to prove, but every now and then a powerful piece of evidence arises. We think Thursday’s market reaction to October’s US Consumer Price Index (CPI) report is one such piece. If you dig into the details, there is little fundamental reason the news should spur the S&P 500 to jump 5.5% on the day.^[i] Yet jump it did, which we think speaks to how sour inflation-related sentiment is. If a modest deceleration for quirky reasons could spur such a big relief rally, the inflation wall of worry—which stocks legendarily climb—must be very high indeed.

To be clear, the CPI data were encouraging. The headline year-over-year inflation rate slowed to 7.7%, which is high—but below consensus expectations for 8.0% and significantly slower than September’s 8.2% rate and well off June’s 9.1% high.^[ii] Core CPI, which excludes volatile food and energy prices, also slowed, from 6.6% y/y to 6.3%.^[iii] On a month-over-month basis, headline CPI matched September’s 0.4% rise, while core slowed to 0.3% from 0.6%.^[iv] But under the hood, things were mixed. Energy flipped from September’s -2.1% m/m drop to a 1.8% rise as falling household natural gas utility prices couldn’t offset a 4.4% jump in oil-based fuels.^[v] Core goods prices fell -0.4% m/m, which seems promising at first blush, but that stemmed primarily from used cars (down -2.4%) and apparel (down -0.7%).^[vi] Recreational goods, most personal care products, new cars and a broad spectrum of household products all endured another month of rising prices. Meanwhile, services’ deceleration from 0.8% m/m to 0.4% stems primarily from a -4.0% drop in health insurance costs, which is mostly an imaginary figure.^[vii] The measurement of Health Insurance CPI is bizarre, reflecting health insurance firms’ retained earnings rather than actual health insurance prices.

Will inflation continue to slow from here? We can’t say with certainty, but we don’t expect inflation to stay super high. There are many signs it is likely to slow, including falling commodity prices. Home prices are also rolling over, which should feed through into the shelter component of CPI in the months ahead. Ditto slowing money supply growth and easing supply chain conditions. All are down from the red-hot levels that fed into CPI earlier this year, and prices are slowly digesting all these changes. So to us the outlook is positive. But we think it is premature to argue October’s CPI report confirms this.

But in our view, it doesn’t necessarily need to. With sentiment so dour, almost any positive surprise could trigger an outsized reaction. The inflation outlook didn’t suddenly get better today—the conditions we think point to slowing inflation ahead have been in place for several weeks now. But investors have seemingly ignored this, getting hung up instead on Fed forecasts and, more recently, the bizarre happenings in cryptocurrencies. But CPI’s deceleration has seemingly jolted that gloom, injecting a dose of inflation hope into stocks. Or maybe it is just the shock acceptance that things can get better and prior extrapolations of high inflation far into the future may not be any more warranted than straight-line math suggesting a quick return to pre-pandemic, low inflation rates.

So if you are investing for long-term growth, we think there are a few broad takeaways for you. One, nothing in October’s report precludes a reacceleration in November, so prepare yourself now not to overreact if that happens—monthly indicators often wobble their way to new trends. Two, don’t expect a huge market jump whenever inflation slows from here. Today’s was serendipitous—enjoy it, but it isn’t predictive. Three, take heart that there remains a lot of room for sentiment to catch up with reality still. Today’s market reaction doesn’t mean the gloom is suddenly gone. There remains plenty of angst over interest rates, bond markets, crypto, the strong dollar, energy prices and all the rest. That creates a big wall of worry for a new bull market to climb, whether one is underway now or not.