Inflation Hot but in Line With Expectations
Right on cue, the latest Consumer Price Index read stole the show to end the week. By now you’re familiar with the headline takeaway: Year-over-year inflation reached a 39-year high.
Once again, we’re here to say Friday’s inflation read makes for a good headline, but it’s critical to look under the hood. Importantly, CPI came in largely as expected. We expected year-over-year inflation to remain elevated, while the month-over-month read slightly decelerated. That was the case in November. The lack of surprises here explains the relatively muted reaction in markets (we’ll dig a little deeper below).
Of course, whenever inflation steals headlines, like a knee-jerk reaction, prognostications about the Federal Reserve are soon to follow. Will the Fed need to tighten sooner? Is the Fed behind schedule? Is the Fed losing its grip on inflation?
To these concerns, we recommend long-term investors take a breath and relax. Rather than worry too much about the timing of the Fed, look at the bigger picture. The Fed is inevitably going to transition from “emergency” monetary policies implemented during the pandemic toward a more normal policy regime. That means we fully expected the Fed to taper its bond purchases and throw in a couple rate hikes in 2022. The question for investors isn’t when, exactly, that happens; rather, the question is whether you believe these measures will hamper economic growth.
In our view, Fed policy will have a benign impact on broad economic growth. The U.S. and global economies remain on solid footing right now, albeit with the potential for short-term disruption from the omicron variant. Regarding markets, the biggest shift we see in 2022 is a greater focus on real earnings, cash flows and valuations. It may prove a difficult environment for hyper-growth “story stocks” with earnings ambitions, but it should favor businesses with durable earnings streams, solid cash flows and lower relative valuations. While markets will likely be volatile next year, we still believe there’s ample opportunity for long-term, patient investors.
Wall Street Wrap
A Deeper Dive on November CPI: Let’s further break down that hot CPI read. The month-over-month increase clocked in at 0.8 percent in November, a hair lower than the 0.9 percent increase the month prior. Year-over-year inflation, the headline figure, rose 6.8 percent in November, the highest mark since June 1982.
Gasoline, food and used and new vehicles were among the larger contributors to CPI, though all components of the index increased. The gasoline component, for example, rose 6.1 percent month over month and 58.1 percent year over year. Keep in mind, energy prices moderated in December, which wasn’t captured in this report. Expect this component to come in a bit tamer next month.
Core CPI, which strips volatile components like food and energy, rose 0.5 percent in November from October and 4.9 percent year over year.
As we stated in our Q4 Asset Allocation Focus, a wave of goods demand has been a major factor in boosting headline inflation. Coming out of COVID-related restrictions, consumers spent big on appliances, vehicles and other items that need to be manufactured and shipped. That’s put immense pressure on supply chains and manufacturers to meet demand. As a result, prices for durable goods have risen sharply over the past year following nearly 20 years of flat to deflationary pressure. We expect durables spending will moderate into 2022 as demand is met and consumers shift back to services spending. We also expect improvements in the labor market to help. Speaking of which …
Initial Weekly Jobless Claims Hit 52-Year Low: Weekly jobless claims took a notable tumble last week, hitting 184,000 for the week ended Dec. 4. That’s the lowest level going back to Sept. 6, 1969, when that total was 182,000. While seasonal adjustments may be impacting the number here, it’s still solid proof that the labor market is strong.
Labor market shortages have been a big factor fueling inflation for several reasons. For one, businesses need workers to chip away at growing backlogs and big demand. A labor shortage has also pushed employers to raise wages and offer incentives to attract workers. Those are all inflationary pressures. But as we’ve forecast for some time, the expiration of enhanced pandemic unemployment benefits coupled with a broader return to normal (kids in school, people feeling more comfortable about in-person work) would compel a sizable return to the workforce. We expect the labor market to continue this positive trajectory into 2022, and that should further help alleviate pricing pressures that have been a major focus for markets.
Consumer Sentiment Improves, Particularly for Lower-Income Respondents: Consumer sentiment slightly improved in December, reaching 70.4 (versus a read of 67.4 in November), according to the University of Michigan Consumer Sentiment Index. While an improvement, December’s reading is squarely in line with the four-month running average (70.6).
Going deeper, a notable takeaway in December was the marked improvement in sentiment among lower-income households. Sentiment reads here improved 23.6 points versus single-digit declines for middle- and high-income households. That’s the largest one-month spike in sentiment among the bottom one-third of earners since a 29.2-point gain in June 1980. The improved outlook was driven by expectations for improved wages going forward.
Across all demographics, 76 percent of respondents said inflation was a top concern, while just 21 percent cited employment as an issue.
The Week Ahead
Markets will have plenty to chew on this week, as the schedule is packed with data releases in addition to the Federal Reserve’s final policy meeting and announcement of 2021. Here’s how the week will play out:
- Tuesday: After a quiet Monday, Tuesday opens with the monthly “view from Main Street” as the NFIB small-business index hits the wire before markets open. As always, we turn to this document for insights on prices and hiring pressures business owners are encountering. The producer price index for November will provide another perspective of the inflation view in the U.S.
- Wednesday: A lot will be happening mid-week. Retail sales are due at market open, and this is a key read since it will include Black Friday and Cyber Monday spending. It’s retail’s time to shine this month and next. The Federal Open Market Committee will also meet for the final time in 2021, and markets will be keen to hear Fed Chair Jerome Powell’s comments given the latest inflation read and his testimony on Capitol Hill. Recall that Powell’s comments gave markets a jolt on Black Friday when he told lawmakers he would retire the term “transitory” when describing inflation. We explained the subtleties of that decision in more depth when it happened. Regardless, markets may be a bit volatile mid-week as eyes turn to the Fed. In addition, we’ll also get the NAHB home builders’ index and the Empire State manufacturing index.
- Thursday: More housing data is due, with building permits and housing starts dropping at market open. Industrial production and capacity utilization will also be worth a look.
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