Broker Check

A Welcome Reversal for Investors

| May 19, 2024

Last Wednesday’s consumer price index report was one of the most closely watched ones in history. Interestingly, few investors had any conviction on what to expect.

As we’ll cover in this post, the report was a welcome reversal for investors from the first few CPI reports of 2024 because it came in on the softer side. We think there are four reasons this specific report was so important.

First, the first three CPI reports of this year surprised relative to consensus estimates due to large swings in many categories. This highlighted the challenges of seasonal adjustments and clouded the true direction of inflation for investors.

Perhaps the biggest example of the confusion is the glacial improvement in shelter inflation. It’s progressed at a far slower pace than many people expected or wanted:

Second, going into the report, as our readers know, we were expecting a softer overall reading than in the past. That came to fruition as the CPI increased 0.3% on a month-over-month basis, which was in line with consensus:

This is important because it's the first time since December that monthly “core CPI,” which excludes volatile food and energy prices, came in at or below 0.3%. This led to a year-over-year rate of 3.6%, which was in line with forecasts:

The fact that the CPI release did not overshoot forecasts immediately led to major stock indexes rallying, Treasury yields tumbling, and an increase in implied probability that the Federal Reserve would start cutting interest rates in September. In a bit we’ll examine how the biggest incremental driver of this report is the long-awaited rolling over of auto insurance costs.

Third, Fed Chair Jerome Powell recently spoke in Europe, where he once again reiterated the U.S. central bank’s dovish stance. This is important because leading up to this report, it was further conviction of the Fed’s stance remaining dovish, particularly relative to Wall Street’s consensus.

Powell’s statement related to inflation’s individual parts was telling:

The key point of Powell’s comment is there are three vital moving parts to inflation – goods, housing, and non-housing services – that can work together to achieve the overall goal.

The fourth reason this latest CPI report was so important is due to auto insurance and shelter costs being the stickiest pieces of inflation, as we’ve pointed out. Prior to the report, we were fortunate to see a peak behind the curtain in the April producer price index report.

April’s PPI inflation figure for property and casualty insurance was 0.1% after three straight months of 0.4% readings:

This was a significant drop and a clue to what we’d see in the CPI report.

The forward-looking PPI data correctly foreshadowed the CPI report’s slowdown in auto insurance costs, which came in at 1.76%. The prior reading was 2.58%, so 1.76% is a huge deceleration (and just the start of a larger decrease, in our opinion):

As our readers might recall, auto insurance accounted for 0.59% of the excess 1.87% year-over-year CPI over the long-term.

We believe these consumer and producer price reports are telling because inflation’s downward momentum should carry into the May reports too. The significance of this cannot be understated. Big disinflation is still in the pipeline.

Interest Rates Falling, Stocks Rising

This data now strengthens the expectation for interest rate cuts and increases the number of these expected cuts by the Fed in 2024. Immediately following the CPI report, the federal funds rate futures expectation of September rate cuts rose from 65% to 73%.

There was a consensus estimate of about 1.8 cuts by the end of this year, but now it’s 2.5 cuts or more:

The good April CPI essentially shatters the bearish “inflation accelerating” thesis. It also provides data support for the strength seen in equity markets in May leading up to last Wednesday.

Thus, we continue to lean towards expecting stocks to continue to show strength for the rest of May. This idea is further supported by recent “big money” institutional investor activity, as shown by our friends at MAPsignals.

In the days leading up to the CPI report, there was a significant increase in strong buying after a period of weakness:

As the chart shows, there were six consecutive days where “big money” buying outnumbered selling by 60% or more. In other words, out of 10 unusual volume signals generated, six or more were buys for six consecutive days.

This is a significant occurrence.

Typically, out of thousands of stocks, only about 100 or so show unusual buy or sell signals on an average day. But in the six days leading up to the CPI report, the average daily count of all signals was 143.7 – substantially higher than the 35-year average of 85.1.

So, this buying is real, not just a low-volume bounce after a rough patch in April.

For further context, below is some data on the other times there were six consecutive days of buying since 1990. This is actually somewhat common, happening about 28% of the time. In the past, positive forward market returns have often followed:

What sets last week apart from those other instances is the strong buying appeared after a vacuum of buying. History tells us the return profile in these circumstances is even better:

It's almost like the market, especially “big money” investors, knew what was coming regarding inflation last Wednesday. As the data shows, positive returns are more likely than not to unfold in the months ahead, which bodes well for long-term investors who stay the course and are data dependent.

* Links to third-party websites are being provided for informational purposes only. CoreCap is not affiliated with and does not endorse, authorize, or sponsor any of the listed websites or their respective sponsors. CoreCap is not responsible for the content of any third-party website or the collection or use of information regarding any websites users and/or members.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.