The S&P 500 finished the week lower but if you had told most investors before Wednesday’s consumer price index (CPI) for June that an eye-popping 9.1% headline year-over-year inflation print (consensus estimates were 8.8%), would result in stocks closing only -0.9% lower on the week, most would have viewed such an outcome as a best-case scenario. The last few CPI reports have coincided with stocks breaking down to new lows, so why has the market reaction been different so far? We suspect two major developments enabled stocks to hold on to about half of the prior week’s ~2% gains despite such a hot inflation report.
First and probably most important, commodity prices have finally begun to roll over. For example, in the last month, oil, natural gas, cotton, wheat, and copper have all fallen over 20% and many of these commodities have returned to levels not seen since before Russia’s invasion of Ukraine. Furthermore, the declines have been very broad with the Bloomberg Commodity Spot Index, which tracks 23 energy, metal, and agriculture futures contracts, down more than 20% after hitting a record in June. As a result, while June’s CPI came in at fresh 41-year high, the peak inflation narrative has been able to remain intact as bulls are betting that the last month of commodity price declines will be better reflected in July’s inflation numbers.
Second and likely a direct corollary of the recent decline in commodities, particularly oil and gasoline prices, Friday’s consumer sentiment report showed the largest decline in long-term inflation expectations in a year. Ever since Fed Chair Jerome Powell noted rising consumer inflation expectations were a major reason for hiking 75 basis points in June, markets have begun to key on this data point. Therefore, we doubt it was a coincidence that the S&P 500 rose over 1.9% on Friday after the morning’s consumer sentiment report indicated five-year inflation expectations had fallen to 2.8% in July, down from 3% in June, which was also revised lower.
Next week will be fairly quiet on the macroeconomic data front, but the Q2 earnings season is heating up and we will be closely watching Wednesday’s existing home sales for insights into how the Federal Reserve’s rate hikes are impacting one of the most interest rate sensitive areas of the economy.
Ian G. Browning, CFA
Managing Director, Investment Strategies | Shareholder
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