Inflation Monster

The Inflation Monster

It is not easy to tame inflation and we saw evidence of that in the CPI (Consumer Price Index) and PPI (Producer Price Index Price) data that was released this week. To summarize, price declines accelerated for hard goods while price increases accelerated for services. The sticky inflation data caused traders to re-price the first rate cut from May to June and I think soon it will get pushed back even further unless growth drops off a cliff in the coming weeks.

CPI Services

As you can see in the graphic above, services inflation in the CPI is spiking higher and maybe it is a one-month wonder but Core Services are where consumers do a majority of their spending.

If we also look below at the services sub-component of the PPI, you can see it also has prices rising in January (far right). The prices producers pay represent inflation in the pipeline as they must pass their costs to their customers and this means that consumer prices will remain elevated in the coming weeks/months.

PPI Services

There has only been one higher reading than Friday’s PPI since 2022 which means most of the progress over the last year has been wiped out rather sharply. Perhaps, it won’t last but it does mean the capital markets may be on the verge of re-pricing this change in inflation expectations.

Interest Expenses are Rising

Government Outlays

Markets also need to consider that interest costs will weigh not only on the private sector but also the US government. Low rates for many years have enabled the federal government to borrow at negligible costs and that is changing as you can see in the adjacent graphic.

The concern is that rising interest expenses will eventually weigh on economic growth and asset prices. And this is one of the reasons that the current expectations of multiple imminent rate cuts is significant as this reality has not hit the political class.

Long-Term Bond Yields

Below is the yield on the 10Yr Treasury bond and my current expectations is that we will see higher yields in the coming weeks before this tenor turns down again later this year. As we go into 2025 and beyond we should see 10Yr yields over 6%.

10Yr Treasury Yields.

By the way, this does not predict a change in the Fed Funds Rate as that is controlled by the Fed. But it does warn that the cost of credit is going to rise and seeing large federal deficits and a large refinance wave in the coming three years it wouldn’t be a surprise for bond investors to demand higher compensation.

The Stock Market

It is good to keep in perspective some of the long-term metrics of the stock market and we have an interesting chart below from The Daily Shot.

Concentration Risk of Stocks

This chart shows that we are at an all-time high with market capitalization risk. Today, the top 10% largest stocks represent 75% of the value of the entire stock market. This is what a thin market looks like and this chart goes back to 1926! If only a few of these stocks begin to underperform (like Tesla) then the major indices will have a hard time holding up at these prices. The last two tops in 2000 and 1929 did not end up well in the following years.

The S&P 500

I’ll end with the chart of the S&P 500 ETF and notable is the price action since the October 2023 low. If you remember, that reversal was kicked off by improving inflation data and the consensus that there would be several rate cuts in 2024. So, if reality sets in and stocks re-price, we may see much lower levels in the coming weeks.

The S&P 500 ETF.

 

Paul McCarthy, President of Kisco Capital, LLC

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Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.