Unique Market Connections

Inflation The top-line inflation number came in better than expected and going in the right direction. This is the one-year anniversary of when inflation peaked last year at 9%. This is a year-over-year number, which means inflation is 3% off of 9%. With inflation moving from 9% to 3%, that’s still a fast move in 12 months. This shows that whatever the Fed is doing seems to be having a positive impact on inflation. The challenge is that when you dig into the numbers, core inflation is stubbornly still near 5%. The main difference between core and top-line inflation in this report is energy. Energy year-over-year transportation costs are down 4.67%. That’s the big driver in the top line number is lower. If you look forward, the risk there is that, more recently, energy prices have started to increase. The month-over-month energy is actually a boost to recent inflation. This may be a discount not being considered going forward, which could explain another phenomenon we noticed. If you look at yields, the CPI has come down. A chart shown in this episode shows that CPI has come down from nine to three percent over the last two years. The 10-year treasury rose with CPI and has stayed stubbornly flat around the four percent range. It doesn’t look like the bond market is pricing in this continued drop in inflation, and in fact, it may be pricing in future higher inflation, which is concerning. Looking back to the 1970s, CPI went up and came down but then went back up again. At the same time, the 10-year yield never came back down and continually increased through that, predicting future hikes and inflation. The market right now is positive on this low print, but it’s concerning to see that the bond market is not expecting that low print to stay. We may see higher inflation from here, which is a bit concerning. Even though these numbers are coming in well below expectations, the market still expects the Fed to raise interest rates at the next meeting in late July. This could be concerning to equity markets if that does come to fruition. Another interesting topic we’ve noticed is that import prices have decreased, which has also helped lower costs. We may be importing deflation from China, which is a surprise and something we haven’t seen in many years. There are a lot of global connections to these numbers and data that we are watching closely.     International Stimulus As investment managers, we look at a lot of data and potential market-moving events. It’s no secret that it’s a global economy and global markets, so we look at domestic and international events that could affect the global markets. One we’ve never discussed on our vlog is the credit impulse indicator from China. The credit impulse indicator measures the change in new credit issued or, better put, a stimulus as a percentage of GDP in China. We’re watching this indicator closely because while the U.S. Federal Reserve is tightening liquidity, which is lowering inflation, we’re starting to see China increase liquidity. Why does this matter, and why are we watching this indicator? Historically, U.S. equity markets have benefited when China has increased liquidity through stimulus. Our analysis shows that if China does stimulate and Chinese credit begins to expand, U.S. equities would likely benefit. During periods where the credit impulse measure indicator expanded in the past, the S&P 500’s median advance was 12.5%, with five of the six periods showing positive returns. More importantly, we look at this to see what sectors would benefit the most, and in this case, Energy and Materials have historically benefited the most. We use this analysis in building our portfolio strategies, so we’ll continue to follow this.   The U.S. Dollar We’ve had many inquiries from clients this year about the U.S. dollar. Some are fearful that the U.S. dollar won’t become the reserve currency. We don’t share those fears, bu