The latest CPI inflation report was just released this morning, and so far it’s put markets in a very good mood. The details were certainly encouraging with headline inflation flat month over month, and up only 3.2% year over year. Core CPI was only 0.2% higher on the month and 4% YOY, which is the lowest in two years.
The reaction was swift with stock futures jumping and bond yields plunging. This goes to show that as much as the markets HATED high & rising inflation last year, they’re similarly relieved now as it continues to descend the other side of the mountain. From the Fed’s standpoint, this solidifies that there will be no hike in December at a minimum – with rising odds that they’re altogether done now. In fact, the market is now anticipating that their next move will be a quarter-point cut in June of next year.
Today’s positive knee-jerk reaction does make sense in the context of the longer-term history of inflation and stocks. If we look at monthly CPI readings since 1927 divided into even quintiles (meaning that 20% of observations are in each), we can see that the S&P 500’s returns are strongest in the 2nd and 3rd quintiles when inflation is positive but low (between 1.1 – 3.2%). CPI first slid back into this “sweet spot” in June when it fell to 3% YOY, after being in either the 4th or 5th quintile since April 2021. Following a brief uptick the last couple of months, today’s report helped to confirm that the downward trajectory into the middle quintile is intact.
Of course, this has nothing to do with other aspects of the economy, earnings, etc., where there are some risks looking ahead. But on its own, inflation is clearly turning from a headwind to a tailwind for stocks as it continues to moderate.
Source: Bloomberg, Bureau of Labor Statistics as of 11/14/23
Carl Noble, CFA®
Senior Vice President of Investments
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