WILL SEPTEMBER’S CPI ALSO SURPRISE ON THE UPSIDE?

August’s PPI was above expectations.  Final demand PPI increased 0.7% from the prior month and 8.3% from a year ago, a fresh series high.  Excluding the volatile food and energy components, the core PPI advanced 0.6% and was up 6.7% from August of last year.

Perhaps more disturbing was the older style finished goods PPI metric, hit 10.5% y/y—the highest reading since 1981.  How much of this increase would be able to be passed onto the consumer?

The answer is pivotal.  In the past 10-12 years producers essentially absorbed these costs in a no pricing environment.  During the past six months theses costs have been able to be passed onto the end user.

Tomorrow the CPI is released and some firms are already suggesting (Goldman and B of A) the data could exceed the 0.4% monthly or 5.3% y/y expected increase.

As widely known the Fed has adamantly stated inflationary pressures are transitory, the result of bottlenecks, supply disruptions and labor.

While I too believe inflationary pressures will moderate, the question is how much?  The Atlanta Fed suggested last week the new inflation speed limit may become 3.0% up from 2.0%.

August 2020 the Federal Reserves stated its new inflation and growth policy that it would permit above average growth and inflation for a period of time, the issue at hand it did not define how long or how much.  Is it now defined?

As stated the answer could be pivotal as Treasuries trade on current and future inflationary expectations.  An expected 3.0% inflation rate will have a considerable impact on Treasury prices that were priced off of a 2.0% inflation rate.

Continuing with the inflation theme, last week it was reported prices paid to producers in China jumped in August from a year earlier by the most in 13 years.  China was formerly the low-cost producer and is/was a major cause for “Price is the only determinate of a purchasing decision” environment to evolve. Goods were manufactured cheaply in China and then sold in the US.  Labor is the largest cost of production but an argument can now be made China has lost this edge.

Last week China, for the first time in history announced it was releasing oil from its strategic oil reserve to lower production costs and inflationary pressures.  Oil dipped on the news but only to recover.

What is this suggesting?

Friday former Treasury Secretary Lawrence Summers and Harvard’s Economic professor Ken Rogoff commented that today is similar to the late 1960s and 1970s.  Both are not suggesting the return of double-digit inflation but warned of inflationary pressures considerably higher than the levels forecasted by the Federal Reserve partially the result of China coming to age and the end of the lowest cost producer, similarly to the coming of age of the newly rebuilt Europe that occurred in the era of fifty years ago.

Rogoff and Summers cited other similarities including a radical change in entitlement programs and a Federal Reserve that became increasingly involved in social objectives and issues.

I am an ardent believer that it is never different, there are just different people.  History is a major guide post for tomorrow.

Commenting on recent market activity, according to Bloomberg more than half of the companies in the S & P 500 have declined at least 10% since May.  Over 90% of the Russel 2000 have declined over 10% in the same period.

If it were not for FAANG, Bloomberg writes the average stock in the S & P 500 would be down over 10%.  Writing it differently, the FAANGs are supporting the S & P 500.

If earnings dictate stock direction, the Russell 2000 should be crushing the S & P 500.  Again quoting Bloomberg the growth in small cap profit margins was 124% last quarter and has outpaced large cap’s profit margin by a factor of four since March 2020.

Obviously there is another disconnect if we are student of history.

I continue to believe Main Street will outperform Wall Street for the foreseeable future.  According to Bloomberg and based upon the increase in profit margins, such is occurring.  Will equity prices soon follow?

Only tomorrow can answer this question.

What will happen today?

Last night the foreign markets were up. London was up 0.77%, Paris up 0.80% and Frankfurt up 1.05%.  China was up 0.33%,  Japan up 0.22% and Hang Seng down 1.50%.

The Dow should open moderately higher even as Chinese technology stocks tumbled after a report that officials are seeking to break up Ant Group’s Alipay. The 10-year is up 1/32 to yield 1.33%.

 

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. The material provided in Daily Market Commentaries or on this website should be used for informational purposes only and in no way should be relied upon for financial advice. Please be sure to consult your own financial advisor when making decisions regarding your financial management. Members of FINRA and SIPC, Capitol Securities Management is a privately owned full-service retail brokerage and investment advisory firm headquartered in Richmond, Virginia. For nearly 30 years, we have been serving the needs of our investors. Today, more than 200 Capitol Securities Management investment professionals and support staff serve approximately 18,000 customer accounts from Southern Florida to the New England coast.