The inflation rate ticked higher in July…
That’s going by the Consumer Price Index (“CPI”) figures the government released last Thursday.
The CPI tracks prices for a range of commonly purchased goods and services – including food, energy, rent, health care, and education.
And it showed an average year-over-year rise in prices of 3.2%.
That’s up from the 3% year-over-year rise in June.
And it set alarm bells ringing.
A sustained increase in the rate of inflation would force the Fed to keep on jacking up interest rates.
That chokes economic growth, which is bad news for stocks.
But as I’ll show you today, this isn’t the start of a new inflationary wave. Instead, it’s a blip on the way to even lower inflation.
That means our bullish call for 2023 remains intact.
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My job as editor of the Cut is to make sure you never miss one of their moneymaking ideas.
I’m also here to help you get the big picture right about where markets are headed.
And for the past 12 months, I’ve been showing you how a falling inflation rate – aka disinflation – is a powerful tailwind for the stock market.
Think of inflation as a “gear lever” for stocks…
A rising rate tends to send stocks lower. A falling rate sends them higher.
Thousands of PhDs have been written on this topic. But when you boil it down, rising inflation tends to put the Fed into rate hiking mode. Falling inflation tends to lead to lower interest rates.
That impacts economic growth… and, in turn, corporate profits.
Don’t just take my word for it.
Below is a table of returns for the S&P 500 between 1928 and 2020. And it’s split into four different inflation scenarios – rising inflation, falling inflation, inflation at 3% or more, and inflation at 3% or less.
When inflation was rising, the average annual return for the S&P 500 was 6.7%. But when inflation was falling, the average annual return for stocks was 16.5%.
It’s a similar story when you look at the 3% inflation threshold.
When inflation was lower than 3%, the average annual return of the S&P 500 was 15.7%. When it was higher than 3%, that plunged to 6.3%.
That’s a massive difference depending on what inflation is doing.
That’s why I’ve been sounding a bullish note on stocks this year…
As I wrote in your January 30 dispatch after noting a drop in the CPI…
[If] inflation continues to slow… 2023 could end up being a very good year for the stock market.
And despite the slight uptick in July over the June CPI reading, I’m sticking to that call.
Remember, the CPI measures price changes for a basket of goods and services across eight categories. They are…
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Food and beverages
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Housing
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Apparel
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Transportation
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Medical care
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Recreation
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Education and communication
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Other goods and services
And in July, 90% of the rise in the index came from rising housing costs.
Housing costs account for about one-third of the CPI weighting. So, they have an outsized effect on the headline inflation number. And rents have risen 7.7% from a year ago.
If we strip out rising housing costs, July’s CPI was up 2.5% year over year.
And Fed researchers expect housing costs to “slow significantly” over the next 12 months. That’s due to new supply coming into the market, which will ease pressure on rents.
If they’re right, inflation will be back within the range of where the Fed wants it – somewhere between 2% and 3%. And it will be the end of the inflation crisis.
This will make the Fed’s rate hike last week the last in this cycle.
And as I’ve been saying all year, once the Fed stops hiking rates, stocks will take off.
I’ll be watching closely for signs I could be wrong…
If we get a spike in energy prices… or something else that could lead to rising inflation… you’ll be the first to know about it.
My motto in these pages is, “Sometimes right. Sometimes wrong. Always in doubt.”
I can’t guarantee the disinflation trend of the past 12 months will continue. But given the outsized role housing costs played in the recent uptick… I’m confident it will.
If we use history as our guide, that’s great news for stocks.
Regards,
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Chris Lowe
Editor, The Daily Cut