CWS Market Review – June 13, 2023

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Inflation Falls to a Two-Year Low

We had some very good inflation news today. For the 12 months ending in May, consumer inflation increased by just 4%. That’s the lowest rate in more than two years.

Last month, consumer prices rose by just 0.1%. That was in line with expectations. Excluding food and energy, prices rose by 0.4%. That also matched expectations. Over the last 12 months, core inflation increased by 5.3%.

A 3.6% slide in energy prices helped keep the CPI gain in check for the month. Food prices rose just 0.2%.

However, a 0.6% increase in shelter prices was the biggest contributor to the increase for the all-items, or headline, CPI reading. Housing-related costs make up about one-third of the index’s weighting.

Elsewhere, used vehicle prices increased 4.4%, the same as in April, while transportation services were up 0.8%.

Egg prices fell 13.8% in May for their largest drop in 72 years.

The headline inflation rate peaked last June at 9.1%. It’s been cut in half since then. I think it’s too early to say that inflation has been defeated. If we were to exclude the last two years, then the current rate of inflation is still near the highest of the past 30 years. Still, this is good news, and it means we’re moving in the right direction.

What does this mean for us as investors? A few things.

First, it’s good news because historically stocks don’t perform well under high inflation. In fact, one of the few things that’s worse for stocks than inflation is deflation. What the market truly loves is stable prices.

For businesses, inflation has an unusual impact on the bottom line. Bear in mind that not all earnings are the same. Inflation exacts a heavy toll on asset-heavy businesses. Inflation has an impact similar to putting a magnet near a compass. Everything gets a little screwy. For example, companies with high assets relative to their profits tend to report ersatz earnings.

At first, inflation gives the illusion of prosperity. Businesses create their products in fewer and more expensive dollars and then sell them for cheaper dollars and more numerous dollars. As an accounting item, the business may appear more profitable, but no wealth has been created.

Inflation also favors the debtor in favor of the creditor. Again, any benefit is short-lived. In fact, once lenders see the impact of inflation, the ultimate outcome is to price the marginal borrower out of the credit markets.

Inflation also causes interest rates to rise. That’s bad for stocks for two reasons. One is that it raises the cost of debt. That makes it harder to finance expansion or mergers and acquisitions.

The other reason is that equity valuations are discounted at a higher rate. That translates to lower earnings multiples. If a one-year Treasury yields 0.17%, as it did three years ago, then buying stocks is a no-brainer. Nowadays the one-year Treasury yields 5.17%. Socking your money away for a small return isn’t for me, but I understand why a lot of folks would be tempted. It’s about as low risk as you can get.

It’s no surprise that the stock market rallied nicely today after this morning’s inflation report.

Expect the Fed to Pause Tomorrow

The Federal Reserve began its two-day meeting today. The policy statement will be released tomorrow at 2 p.m. ET. It seems very likely that the Fed won’t make any changes to interest rates. This will be the first time in 10 meetings that the Fed has decided to forego a rate hike. The current target range for the Federal funds rate is 5% to 5.25%.

In the futures pits, traders currently place a 96% chance that the Fed will leave interest rates alone tomorrow. That’s up from 79% before the inflation report.

Traders also think there’s a decent chance that the Fed will hike next month, but they also see that rate hike being taken back before the end of the year. The consensus is that we’re at or very near the peak in the interest rate cycle. I don’t have enough confidence to make a specific prediction about interest rates at the moment, but I think it’s safe to assume that interest rates will likely start to trend lower later this year.

The stock market liked today’s inflation news. The S&P 500 closed higher for the fourth day in a row. This was also the tenth rally in the last 13 trading sessions.

The S&P 500 reached its bear market low eight months and one day ago. Since then, the index has gained more than 22%. Even after an impressive rally, the stock market is still about 9% below its all-time high from early 2022 (not including inflation). In retrospect, it seems clear that inflation hurt stocks last year. The S&P 500 lost one-quarter of its value in ten months. Once it became clear that inflation was fading, the stock market turned about.

Some Updates to Recently Featured Stocks

I want to briefly update you on some stocks we’ve talked about recently. Six weeks ago, I told you that Hingham Institution for Savings (HIFS) was my favorite regional bank. This was during some of the mayhem that plagued the sector earlier this year. A great stock-picking strategy is to find a sound name in an industry that’s getting hammered. Since then, shares of HIFS are up 22%.

I’ve mentioned United States Lime and Minerals (USLM) several times, and the stock seems to go higher every week. The shares are up more than 30% since I highlighted it for you in January. The stock hit another new 52-week high today. The Q2 earnings report should be out in late July.

In February, I told you about UFP Technologies (UFPT). The company makes custom packaging for the medical industry. The stock is up 57% since then.

I haven’t had all home runs. In January, I said nice things about Dollar General (DG). It’s important to look at our duds as well. This stock has been a trainwreck since then. I even came close to adding it to our Buy List to replace Ross Stores (ROST).

To be fair, at the time, I noted some of the issues DG was having. I said I wouldn’t consider adding it until the problems are past them. They’re not. The stock is down 30% in the last four months. I hope to see a rebound here, but I want to see solid evidence first.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

P.S. If you want more info on our ETF, you can check out the ETF’s website.

Posted by on June 13th, 2023 at 7:35 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.