During a week hallmarked by hot inflation data, the S&P 500 ended a three-week streak of gains and fell almost -1%. However, this week’s decline is not particularly surprising, as despite a flurry of recent all-time highs, market breadth – or the number of advancing to declining stocks – has deteriorated over the last two months and market leadership has become narrowly focused to just eight mega-cap stocks. For example, Apple, Amazon, Facebook, Alphabet, Microsoft, Netflix, Nvidia and Tesla, make up over 25% of the S&P 500’s total market cap, but have accounted for more than half of the S&P 500’s roughly 7.5% gain since May 12th. Therefore, this week’s weakness is consistent with a broader market that has grown a bit tired and probably needs to consolidate after a banner first half to 2021.
Inflation – Transitory or Not?
Both the consumer price index (CPI) and producer price index (PPI) for the month of June were released this week and handedly exceeded expectations as they each rose at their fastest rates in over a decade. June’s CPI rose 5.4% from a year prior, the fastest since August 2008, while core CPI, which strips out food and energy, rose 4.5%. PPI for June, rose even more, up 7.3%, the most since the report started being recorded in 2010. Interest rates, however, moved materially lower for the week, which seems a bit counterintuitive as inflation is typically terrible for bond investors as it erodes the purchasing power of future bond cash flows. As a result, the continued fall in interest rates is causing some consternation among investors as they wonder whether the bond market is forecasting peak economic growth and/or overblown inflation concerns.
When one looks underneath the headline CPI figures and analyzes the underlying areas of strength, the recent CPI surge looks very selective, and the recent interest rate decline starts to make some sense. For example, over the last three months, used car and truck prices have risen 10%, 7.3%, and 10.5% month-over-month and a whopping 45% year-over-year. This equates to about a third of the CPI surge and exceedingly few economists would extrapolate this sort of used car and truck price growth into 2022. Furthermore, car and truck rental prices have been even more eye-opening, rising over 80% from a year prior. Prices for lodging away from home and public transportation, including airfare, have also been notable areas of strength as they have both risen about 17% year-over-year. Per research from Bank of America, when these four categories (used vehicle prices, rentals, transportation, and lodging) are stripped out of the CPI report, the month-over-month gain for June falls from 0.88% to a much more normal 0.18%! To be clear, more durable pricing pressures are building, particularly around wages, but it is far too early to declare this surge in inflation as sustainable as supply disruptions and the normalization of demand have clearly played an outsized role in surging, but likely transitory, price increases across travel, lodging, and car and truck prices.
Ian G. Browning, CFA | Director, Investment Strategies & Shareholder
Peter E. Simmons, JD | President & CEO