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Good morning. Most people seemed happy about yesterday’s cooler inflation data. But not Jamie Dimon. “I think people are overreacting to short-term numbers,” the JPMorgan chief executive and longtime inflation hawk told Bloomberg. Nonetheless, JPM stock, along with most banks, liked the news. Below, we calibrate our elation levels. Email us: firstname.lastname@example.org and email@example.com.
The good inflation news
No one rings a bell when the rates cycle peaks. But Tuesday’s October consumer price inflation numbers were as close as you get to a neon sign flashing the words, “hey, idiot, soft landing imminent”. With a few minor caveats, the news was all good. Headline and core CPI undershot expectations due to quieter services inflation. Monthly core inflation rose just 0.2 per cent, or 2.8 per cent annualised.
The market read the flashing sign. Bonds rallied; the two-year yield collapsed 21 basis points and the 10-year yield wasn’t far behind at 19bp. The S&P 500 rose 2 per cent and the rate-sensitive small-cap Russell 2000 popped 5 per cent. Futures markets now see no chance of any further rate rises.
The most important detail was the significant deceleration in rental inflation, rising 0.3 per cent in October and reversing an uptick from last month. This keeps the rent disinflation trend intact, a non-negotiable part of any soft landing story. Falling rents on new leases have long indicated that CPI rental inflation, the most influential single component, would moderate. In the big picture this has been happening, though progress has been uncomfortably bumpy (note the spike in the light blue line):
If you need reasons to worry, October’s inflation report contained one or two (as all of them do). A few services categories look persistently hot, especially auto insurance. Methodology quirks in the October health insurance data were supposed to depress medical care inflation; instead, it rose, powered by rising prices for hospital services. The inflation drag from falling used car prices, which has helped create core goods deflation in the last five inflation reports, is diminishing.
But those are just quibbles. The market is right to like yesterday’s report in isolation. The bigger question is how good inflation numbers fit into one’s story of the economy. Here’s how we read it: yesterday’s data took a big bite out of inflation tail risk. After a couple months of CPI releases containing hints of a coming inflation re-acceleration, October’s numbers made that look far less likely. Thus the jubilant market reaction.
Inflation that is trending down more convincingly doesn’t mean mission accomplished, though. There is a strong possibility of a soft landing; but two other scenarios are possible. First, looser financial conditions and falling inflation boost demand, and keep inflation stubborn. Second, inflation keeps falling, but only in fits and starts, forcing the Fed to keep monetary policy restrictive, raising the probability of a slowdown. (This is to say nothing of exogenous shocks such as, say, an oil price surge stemming from Middle East supply disruptions.)
Suppose the Fed starts cutting rates next year to “normalise” the stance of policy, that is, to keep real rates steady as inflation falls. That would not mean monetary policy is much looser, but markets could interpret it that way. How will tight policy and looser financial conditions net out? This illustrates the complexities of ending a tightening cycle while inflation is above target and only falling slowly. Martin Wolf doesn’t exaggerate when he writes that “policymaking is now at a truly difficult point in the cycle”.
We don’t mean to alarm, but to caution. It is a good thing that soft landing seems so attainable. But there is still a way to go. (Ethan Wu)
Food (stock) poisoning
Food stocks returns have been disgusting this year. It is hard to find a subsector of the market that has done worse. All 14 food stocks in the S&P 500 have underperformed the broader index by at least 8 percentage points. The cap-weighted return for the subsector is minus 12 per cent, a whopping 28 points behind the market. Even that nauseating number is pulled up by the not-terrible performance of Mondelez, which makes up a quarter of the group. Take Mondelez out and the group is down 18 per cent:
This is particularly odd at a moment when, according to the latest edition of the Bank of America fund manager survey, professional investors are slightly overweight staples stocks. What is more staple-y than food?
We have written several times in recent weeks about how defensive stocks have done poorly lately. No explanation of this is totally satisfying, but the most general is that staples outperformed during the wretched and scary year 2022, as one might expect, and now they are giving that outperformance back, while at the same time rising bond yields have made high-yielding staples less appealing as bond substitutes.
But the case of food companies is extreme. Part of it can be explained idiosyncratically. Several of the S&P food stocks are simply performing badly. Many companies in the group are only generating revenue growth because of price increases; volumes are flattish. But ConAgra, Hormel and Tyson aren’t even managing price increases. Kraft Heinz is getting price, but only at the cost of falling volumes. Both Campbell’s and Smucker’s have made big acquisitions (Rao’s pasta sauce and Hostess snacks, respectively) that investors didn’t seem to like.
But these individual failures, it seems to me, don’t quite account for the stomach-churning performance of the group. Mondelez (snacks) and Lamb Weston (frozen french fries) are succeeding on both price and volume; both companies have good fundamentals and good track records. Still, they lag the market. And a lot of the stocks in the group, even considering their sluggish growth, look very cheap. It can’t all be down to the GLP-1 diet drugs.
I’m not sure what to make of this, except to say that during all of this year’s ups and downs, investors have not cared to play defence in stocks. Given today’s cheerful inflation report, they seem unlikely to start now. There will come a time to feast on food stocks, but not quite yet.
One good read
“In British politics, the appearance of competence is more important than the evidence of it.”