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It was surely not a great sign that stocks:
- sold off big Friday
- did not manage to bounce Monday
- did not manage to bounce on turnaround Tuesday
- Thursday is month-end
- Friday is the day before Labor Day weekend
Underlying the rising “despair and resignation” of investor sentiment is the view that inflation is “sticky” and will only come down gradually. And if incoming economic data is strong, this raises concern that the Fed has to do more. So, you can see the mounting despair this creates:
- good news is bad news = Fed has to do more
- inflation is “sticky” and therefore easy to dismiss signs of easing = bar is high
- the JOLTS survey (job openings) posted an upside surprise for July (11.2mm vs 10.4mm Street)
- Case-Shiller home prices rose +0.44%/ +18.65% MoM/YoY for June, pointing to continued strength in housing
- both JOLTS and CS data are pretty stale, arguably. CS is 8 weeks old. JOLTS 6 weeks old.
10 thoughts to suggest inflation could fall more “like a rock” than a “feather”
Inflation is mysterious and uncertain. But the notion that inflation lingers and is sticky primarily stems from the epochal inflation episode of the 1970s to 80s. Even after reading Ben Bernanke’s 21st Century Monetary Policy, the factors driving that steady rise in inflation were multiple, complex and not clear that applies to 2022.
To counter the chorus inflation despair, here are some counter-perspectives:
- consensus seems to believe inflation will only fall “like a feather”
- but many components are “dropping like a rock”
- 42% of CPI components are declining from recent highs = deflation
- 25% based upon GDP weight, compared to 10-yr avg of 39%
- meaning, getting to 2% requires 14% more components to see weakening prices
- looking at regional CPI, 5 of the 9 US regions saw outright “deflation” in July (m/m)
- these 5 regions represent 49% of GDP
- in East North Central (WI, IL, MI, IN, OH), CPI annualized is -3.96%, outright DEFLATION
- leading indicators like manheim (autos), hopper.com data (airfares), Redfin (real estate) suggest many other components of CPI could start falling outright
In other words, there are many counterpoints to suggest inflation could fall faster than consensus expects. This, in turn, would change the path of Fed policy. Arguably, the inflation swaps markets are already reflecting this, hence, the lower levels of implied inflation.
Rockets and Feathers: the adage prices move up like a rocket and fall like a feather
I have heard many economists say prices are like rockets (moving up) and feathers (falling). The title of FRED blog below is as such.
- price increases are passed on quickly
- but price decreases only come slowly
- by implication, this means investors will likely expect inflation to rise fast
- but only drift down slowly
- hence, feathers
Feathers is one reason many are now diminishing signal of downside July CPI
And this idea that prices move downwards only slowly is one reason many are diminishing the downside surprise from the July CPI.
- monthly prices fell outright in July
- as chart below shows, this is an abrupt break in pattern
Many components are starting to fall like rocks… not feathers
Looking at the components of CPI, many items are beginning to fall like a rock.
42% of CPI components are in outright deflation from peak
Our data science team, led by tireless Ken, has put together a diffusion of the 175 CPI components. This is shown below and measures the % of components with outright declines in prices:
- if a price is below its 18-month peak, this component is in deflation
- even if the YoY does not yet reflect this
- 42% of components are in outright deflation, up from a 40-year low of 34%
- 25% on a CPI-weighted basis and the 10-yr average is 39%
- thus, to get to “2%” avg of past decade, only 14% more of components need to “deflate”
Many key components are starting to fall like a rock
And the biggies that are not yet deflating are things like autos (4%), shelter (~27%) and durables (5%) and travel (2%). For those using our inflation dashboard (published every Thursday evening), we can see the deflation developing in many of these items.
The top 50 components seeing outright deflation are below. These are sorted by “% off 18-month high”
HOUSING/RENT: History shows even this component falls like a “rock”
If there is one thing I seem to hear often, it is that housing will take quite of lot of time before this component stops inflating:
- home prices are going up due to shortages
- fyi, Case-Shiller price data is lagged as only June was released today
- moreover, many say “rents” will go up because housing is unaffordable
- this is partially true
- but then many also argue “rents” are sticky and will stay elevated for awhile
We were curious whether “rent” and “owners’ equivalent rent” (OER) are truly sticky. So we gathered the data on two big metro areas:
- NYC and SF
The BLS has CPI data for the past 40 years in these metro areas and we charted the YoY growth rate in OER:
- when OER falls, it falls like a rock
- both in SF and NYC areas
- many crashes to “zero” YoY in OER took less than 12 months
The takeaway? Rents could fall a lot faster than many expect.
DISINFLATION: Many regions of US starting to see disinflation
The BLS collects CPI data for 9 regions as listed below:
- the regions have longish descriptors
- this map helps
JULY CPI: 5 of 9 regions saw outright price declines
As shown below, 5 of 9 regions saw outright price declines
- these 5 regions are 49% of GDP
- so much of the nation saw outright price declines in July
- with gasoline falling again in August, many will see declines in August as well
This map below helps visualize where CPI shakes out in July:
- Mountain region had the highest CPI at ~5% annualized rate
- East North Central is seeing prices fall -4% annualized
- yup, deflation
STRATEGY: When markets are in “despair,” Technicals might be the truth seeker
If investors are increasingly resigned to “inflation for longer,” and thus “Fed for longer,” one can see why stocks are still weakening:
- investors have no visibility on inflation inflection
- how quickly inflation falls
- and thus, when Fed can pivot
- our base case, however, is inflation is likely falling faster than consensus expects
- already many leading indicators are falling
- inflation markets see inflation managed
- consumer inflation expectations are falling and for bottom 25%-tile of answer is below average
But when markets lack visibility, then Technicals offer insights. And as noted by our Head of Technical Strategy, he sees an alignment for stocks to bottom short-term:
- There are multiple alignments including Fibonacci, DeMark, Gann among others.
- These are covered in his note from Tuesday evening
- But in short, he sees high probability for a rally this week and into mid-September
STRATEGY: 2H rally view intact
Bottom line. We see 2H rally thesis intact.
STRATEGY: 2022 Bear market was 164 days, or 25% duration of prior bull
Our data science team put together the comparative duration of bull markets and bear markets, and the corresponding ratio:
- since 1942, there have been 14 such cycles
- median ratio of bear vs bull is 31%, meaning a bear market is roughly 1/3 duration
- since 1982, this ratio is only 15%
- in 2022, the preceding bull market was 651 days
- the current bear market was 164 (using 6/16)
- or 25% ratio
As seen below, this ratio is solidly within the ranges seen since 1982.
- many investors think “more time” is needed for this bear market
- but given the shortness of the preceding bull market 651 days versus 1,309 median
- the corresponding bear market should also be shorter
BUY THE DIP REGIME: Stocks already saw fundamental capitulation
And we want to revisit the chart below, which looks at the internals of the S&P 500 — the % stocks >20% off their highs, aka % stocks in a bear market.
- this figure surged to 73% on 6/17
- this was only exceeded 3 times in the past 30 years
- each of the 3 prior instances was the market bottom
- we think this is the 4th instance
BUY THE DIP: forward returns strong
And stocks have the best forward returns when this figure exceeds 54% as shown below:
- in 3M, 6M and 12M
- the best decile for returns
- is when this figure is oversold >54%
- hence, buy the dip regime is in force
33 GRANNY SHOTS: Updated list is below
The revised 33 Granny shots are shown below. The list is sorted by the most attractive (most frequently cited) to least. To be a “Granny shot” the stock needs to appear in at least two portfolios:
- $AAPL in 5 of 6 portfolios
- $GOOGL $MSFT in 4 of 6 portfolios
- $AMZN $META in at least 2
- This reinforces our favorable view of FANG in 2H2022
33 Granny Shot Ideas:
Consumer Discretionary: $AMZN, $AZO, $GPC, $GRMN, $TSLA
Information Technology: $AAPL, $AMD, $AVGO, $CSCO, $KLAC, $MSFT, $NVDA, $PYPL, $QCOM
Communication Services: $GOOGL, $META
Energy: $CVX, $DVN, $XOM
Financials: $ALL, $AXP
Real Estate: $AMT, $CCI, $EXR
Health Care: $ABT, $BIIB, $ISRG, $MRNA, $REGN
Consumer Staples: $BF/B, $MNST, $PG, $PM
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33 Granny Shot Ideas: $AAPL, $GOOGL, $MSFT, $ALL, $BF/B, $CSCO, $NVDA, $PG, $PM, $ABT, $AMD, $AMT, $AMZN, $AVGO, $AXP, $AZO, $BIIB, $CCI, $CVX, $DVN, $EXR, $GPC, $GRMN, $ISRG, $KLAC, $META, $MNST, $MRNA, $PYPL, $QCOM, $REGN, $TSLA, $XOM
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