Inflation: The Magic Number is Four
Last week we found out that inflation measured by the Consumer Price Index (CPI) soared at its fastest 12-month pace in 13 years. The CPI rose +4.2% year-over-year and +0.8% month-to-month in April. Both exceeded economists’ estimates for a +3.6% year-over-year increase and a 0.2% month-to-month increase. Core CPI, which strips out food and energy costs, jumped +3.0% year-over-year.
The Producer Price Index (PPI) also surged in April, rising +6.2% year-over-year. On a month-to-month basis, the PPI climbed +0.6% in April. To put this into perspective, economists were only looking for a +3.8% year-over-year increase and a +0.3% month-to-month increase. Core PPI, which also excludes food and energy costs, jumped +4.6% year-over-year.
Inflation rising above 4% last week proved a shock for inflation-sensitive assets, with bond yields jumping and stocks falling, growth stocks most of all.
And in the chart above you can see that the University of Michigan Survey of Consumers shows that consumers expect inflation to exceed +4.0%.
Just look around us. The +17% year over year gain in existing home prices is the highest ever. Lumber, until a small decline this week, and other building material prices have skyrocketed. Lumber’s price is up 3x since last November; The price of a deck has also tripled in many parts of the country. Food prices are up and climbing. Gasoline prices are up +75% since November as I’m sure you noticed. And Labor costs appear more inflationary than at anytime since the early 1980s.
Wall Street does not like inflation because interest rates head up, and fears are now spreading that inflation could negatively impact companies’ bottom lines. These fears aren’t completely unfounded, but during times of booming economic growth, inflation’s negative impact on earnings is often muted as profits are higher too. Stocks are an inflation hedge if the rise in prices is accompanied with strong economic growth.
And right now, U.S. economic growth is accelerating – the Atlanta Fed expects +10.5% GDP growth in the second quarter and earnings momentum is showing no signs of tapping the brakes either. FactSet anticipates that S&P 500 companies will achieve +60.0% average earnings growth and +18.7% average sales growth in the current second quarter. That’s up from +49.4% average earnings growth and +10% average sales growth in the first quarter.
But don’t worry our Treasury Secretary does not think inflation is a problem because it is “transitory”. And for now the Fed and the Administration are probably correct.
The economy is going from 0-60 in a blink as vaccines give people confidence to buy stuff. The government has supplied so much extra money in the form of extended unemployment insurance and checks from the treasury that supplies of everything are tight and demand is accelerating, therefore, prices go up. But as their argument goes, as supply chains catch up to demand and we lap last year’s bottom in the recession, inflation will settle back near the Fed’s 2.0% target.
A Warning from the Supply Side, On the Verge of Real Inflation.
So the Fed may be too loose especially with a federal government hell bent on reversing the business friendly supply side policies of the last four years. We need to increase supply, not restrict it. But that discussion is for another day. In case you wonder what I mean, look at the evidence below: Small business have NEVER found it harder to get jobs filled.
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