Too Much Fighting the Last War on Inflation

Another month, another wiggle in US inflation data—and another round of mass overthinking. That is our general read of coverage of Thursday’s September Consumer Price Index (CPI) report, which showed headline inflation decelerating from 2.5% y/y to 2.4%.^[i] Core prices (excluding food and energy) ticked up from 3.2% to 3.3%.^[ii] Neither managed to meet expectations for further slowing, which led much of the coverage. But these are teeny, tiny moves, virtually undetectable. Headlines may be stuck on them, indicating investors are still fighting the last war, but stocks have long since moved on.

We know it might seem a little weird to call this “undetectable,” but consider the math. Imagine a hypothetical family whose monthly expenses were $7,000 a year ago. A 2.4% rise from then would take the tally to $7,168. A 2.5% increase takes it to $7,175. $7 isn’t nothing. Similarly, if we knock off $1,000 for food and gas (oversimplified, but please go with it), a 3.2% rise in “core” expenses takes us from $6,000 to $6,192, while 3.3% lifts the total to $6,198. A tenth of a percentage point just isn’t a lot.

You wouldn’t know this from the coverage, which is heightened, Fed-focused and—surprise—exceedingly political. Several outlets noted the frustratingly bumpy return to low inflation and speculated about what this means for the Fed’s next move (always unknowable, in our view). Most noted this is the last report before the election and mused over what this will mean for folks at the ballot box (also unknowable). The uptick in core inflation stole most of the show, as if this is somehow the more real and correct inflation rate—an odd inversion of years past, when higher headline rates were supposedly real while slower core rates were statistical skullduggery.

Our advice? Keep perspective. The factors driving faster core inflation aren’t surprising or indicative of broad acceleration. Shelter—largely owner’s equivalent rent (OER)—has skewed core CPI higher throughout inflation’s gradual slowdown. This category, which is the hypothetical amount homeowners would pay to rent their own house, tends to lag rents and home prices by several months. It is also basically meaningless. It aims to factor in rising mortgage payments, but most Americans have fixed-rate deals, making the movements irrelevant. Another major contributor, car insurance, is an (exceedingly annoying) after-effect of higher auto prices. It also reflects changes in car construction and design that jack up repair costs. Insurance firms aren’t charities, alas, and will logically raise rates in order to stay afloat as claims increase.

Bear in mind, too, that some inflation is normal and will always be with us. It is the natural side effect of economic growth, wealth creation and rising money supply. Rising prices, counterintuitively, are a useful signal to businesses to produce more of the goods and services we all need and want. Society got used to exceedingly low inflation in the 2010s. But much like low rates in that era, this was the exception to historical norms, not the rule. Over time, the average annual CPI inflation rate is around 3%. Sometimes faster in a given month, sometimes slower, but always wiggly.

Perhaps this all sounds a bit out of touch after the pain of 2022’s inflation spike and the slow easing since. Even calling inflation’s path since its peak rate a “slowdown” could feel wrong, since all of our bills are still so darned high. How can inflation be back to normal if we are all still paying what feels like far too much for milk and eggs?

But inflation is the rate of change in consumer prices—not the level. Getting prices back to pre-COVID levels would require deep deflation, which America doesn’t do well. The few times we had deflation in the last 100 years, it was a side effect of big economic problems. When we have had fast inflation, we overcome it not through a reversal of those high prices, but through the inflation rate slowing as wages rise. It takes a while, but it eventually restores purchasing power. Prices are up, wages are up, but our household budgets afford about what they did before the pain set in. This is how America recovered from the dastardly 1970s. And it is how we are recovering from 2022 now.

Social Security’s annual Cost of Living Adjustment (COLA), announced Thursday, is a small way to see this. COLA raises Social Security benefits annually, in line with inflation. Or, technically, the average rate in the CPI for Urban Wage Earners and Clerical Workers in July, August and September. For 2023—following terrible 2022—COLA added 8.7% to benefits.^[iii] This year, it slowed to 3.2%, reflecting 2023’s inflation slowdown.^[iv] For next year, starting in January, COLA will add just 2.5%.^[v] In each case, prices rose, putting pressure on people with fixed incomes, and COLA came after the fact to restore that lost purchasing power. Note, we aren’t saying it perfectly covered every household’s living costs—we have long preached that CPI isn’t a cost-of-living index, and we know the CPI basket looks a lot different from retired folks’ monthly expenses. But in principle, this is how it works.

In our view, inflation is now primarily a personal finance issue—not a stock market issue. Yes, spiking inflation was part of the tapestry of fears that hit sentiment and drove 2022’s bear market. But stocks began recovering before inflation showed material signs of improving. The bull market that began on October 12, 2022 didn’t ebb and flow with every CPI wiggle along the way. Sometimes CPI hit sentiment, but overall, stocks move on expected earnings over the next 3 – 30 months. Inflation tends to have little sway here, as it affects businesses revenues as well as costs, which largely nets out in earnings over time. This is why, in the long run—and despite 2022—stocks are an excellent inflation hedge. So focus on this, and don’t get hung up on little monthly wiggles.