On the surface, the August consumer price index (CPI) came in slightly hotter than expected. Yes, this report breaks the string of two consecutive months of “core CPI” (excludes food and energy costs) month-over-month declines. But the 0.3% month-over-month gain versus the expectation of 0.2% isn’t that bad as it only equates to 3.6% annualized.
We know how markets and the media only care about the margin – and on the margin, this CPI report was a miss. Still, four of the six times during this cycle the CPI has come in slightly hotter than consensus, equities gained in the following week:
Perhaps the CPI miss isn’t entirely bad news. But the details matter because these reports are subject to noise and variability. Plus, our readers know we think inflation is currently in a cycle where shelter and vehicle-related costs are all that really matter at this point (see below). Both are set to fall substantially over the next few months.
Even with this August rise, the Core CPI should keep softening moving forward. In fact, we're already beginning to see deflation. For example, Bloomberg recently highlighted the decline in online goods prices:
Furthermore, after the Federal Reserve’s conference in Jackson Hole, Wyoming, futures related to a November interest rate hike calmed down:
There’s even an increased expectation around rate cuts next year:
The most important data point so far September for stocks though is the 10-year Treasury yield. It’s caused healthy profit taking over the last six weeks or so.
But unlike last year, we don’t think rising interest rates will destroy stocks (we’ll explain shortly). Still, that concern is among four important macroeconomic headwinds that have “shaken” investor confidence recently:
- Inflation jitters
- Rising interest rates
- Fed tightening
- Stronger U.S. dollar
Relative to interest rates, stock prices have been marked down recently. Investors are “worried” that falling inflation will stall, forcing the Fed to keep rates “higher for longer.” In theory, this would weaken economic growth and corporate earnings.
Convinced? Let’s dig into the data.
Here’s what bears miss: even if inflation stops falling and stalls out at 3% or ticks back up to 4%, history shows it’s unlikely to derail the market. Since 1955, the S&P 500* has gained an average of 11% in the 12 months following inflation readings of 2%-4%:
Inflation must eclipse 6% before equity returns suffer. We only need to look to last year as an example when the S&P 500 fell 20% as the CPI shot well above 6%. In our opinion, this is why even if there is “sticky” inflation it won't break the stock market. We don’t think inflation will jump that high because of where we are in the cycle (i.e., falling with just a couple key categories needed to fall more).
That in turn brings us to interest rates. What the bears miss regarding long-term interest rates is they’ve been stable when inflation is running between 2%-4%:
Again, historically inflation needs to exceed 6% before 10-year bond yields jump. Once more, last year provides evidence – interest rates soared with inflation greater than 9%, causing stocks to plummet.
Even if our base case of housing and auto costs decreasing doesn’t materialize and stickier inflation prevails, we don’t think rates will go up much more. And if rates remain stable, it’s supportive for stocks.
From a tactical perspective, we're getting closer to sweet spot in MAPsignals’ trusty Big Money Index (BMI), which is a 25-day moving average of outsized “big money” investor stock buys and sells. Sellers are beginning to slow, enabling the BMI to form a trough before it rises again:
So, history suggests that inflation would need to jump to more than 6% before impacting stock returns and interest rates. Right now, we’re at 3.6% year-over-year. Taken together, this further supports our thesis that this correction should not last much longer and we’re inching closer to a tactical buy signal.
SECURE 2.0 Act – 401(k) Tax Credits
It’s a great time for small businesses to start retirement plans.
The SECURE 2.0 Act of 2022 created new tax credit opportunities and enhanced existing ones for small businesses to establish retirement plans. The new credit is based on contributions employers make on behalf of plan participants. The expanded credit helps offset more employer plan costs.
To qualify, employers must:
- Have no more than 100 employees
- Not have offered a retirement plan during the previous three tax years
New Employer Contribution Tax Credit
This provision is a decreasing percentage of the amount contributed by employers for each employee earning no more than $100,000 per year, up to $1,000 annually per employee. Here is the phase-down schedule for companies with 50 or fewer employees:
For those with 51 to 100 employees, the percentage for the applicable year is reduced by 2% for each employee in excess of 50.
This can be confusing, so here are some hypothetical examples.
Company A has 12 employees, 10 of whom make less than $100,000 per year. Of those, nine participate in the company’s retirement plan. The company provides a 50% match on contributions.
Company B has 70 employees, 60 of whom make less than $100,000 per year. Of those, 54 participate in the company’s retirement plan, which provides a 50% match.
Expanded Plan Cost Credit
Beginning in 2022, this broadened credit reduces the amount of taxes a small business may owe during the first three years it has a retirement plan in place.
For companies with 50 or fewer employees, the credit will cover 100% of the employer’s ordinary and necessary out-of-pocket expenses for the plan (it was 50%). For businesses with 51-100 employees, the credit covers 50% of plan costs. The maximum credit amount is $5,000.
Also, by 2025 plans must automatically enroll employees. But starting this year, companies that include this feature are eligible for an additional $500 credit per year for the first three years.
Naturally, there are several exceptions and details to these credits. The information above is a broad summary.
Of course, each circumstance is unique. If you’re interested in learning more about these credits or how they can help your company, get some expert assistance (the Cornerstone Retirement Group is a good place to start).
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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.