Last year, when our economy began to emerge from the recession and to reopen, so too did concerns of inflation, even though it was below the Federal Reserve’s target interest rate of 2 percent. More recently, some worried that inflation, as measured by the Consumer Price Index (CPI), had crept higher and exceeded that target. At the time, we thought back to our post from 2015 where we quoted Dr. John Williams, then president of the Federal Reserve Bank of San Francisco, when he said, “Inflation is like wine … a little bit is actually good for you.” We, like the Fed, see inflation as transitory, or temporary. But this week, as prices rose before our eyes in nearly every part of the economy, the concern over inflation felt all too real. The April CPI report released this week confirmed this; CPI jumped 4.2 percent, the largest increase since 2008, and above consensus estimates of 3.6 percent.
The CPI measures a basket of consumer goods, energy and housing. Excluding energy and food, which are the more volatile sectors, the CPI still increased 3 percent, the largest gain since 1981. While goods such as lumber were up over 120 percent in 2021, the major factor in the CPI’s jump was used car and truck prices which surged 21 percent.
Many see used vehicle prices as a bellwether inflation indicator for two reasons: one) there is also a new vehicle supply chain and two) it is not seasonal, unlike food or energy. Used vehicle prices are a good example of a component of CPI that is temporary due to short-term factors rather than an indicator of an increasing inflation trend. Current new vehicle manufacturing delays due to microchip and intermediate components are temporary. Rental car companies that reduced their fleets in 2020, are now faced with keeping and replacing their fleets as travel demands increase. These are shorter-duration problems rather than systemic. Lastly, prior to the Great Lockdown, used car prices had grown at a muted rate. The last 12-to-18 months have seen that rate increase from that low level, also known as the “base effect.” For many, the April CPI number may have seemed shocking, but is not unexpected, and we have been positioning our portfolios accordingly.
The Market’s Reaction
The equity market reacted to the higher-than-expected inflation number by selling off early in the week, off 2.7 percent going into Friday. The NASDAQ fared worse, down 4.6 percent as investors cycled out of the high-flying tech stocks and into more cyclical sectors. But that changed Thursday with the Centers for Disease Control and Prevention (CDC) signaling positive news on the reopening front and Friday’s retail sales numbers indicate the market has already started to erase earlier losses. Retail sales in the U.S. was unchanged in April, which is impressive as March’s reading was adjusted up to 10.7 percent month. It seems that consumers didn’t spend all of their March stimulus checks. Though the news earlier in the week was grim, the S&P 500 is less than 2 percent from all time highs. We are currently early in a market cycle where selloffs and pullbacks may be short-lived and quick.
Week in Review and Our Takeaways
April’s CPI reading was a big number we haven’t seen in a while and it may not be the last as we expect inflation to be elevated through the summer
If you are waiting for a large selloff or pullback before putting money to work, it probably will be quick, and the market may have moved before you are ready