Last Friday the government released the Consumer Price Index which showed the highest inflation since 1981, 6.8%. I don’t think anyone in the U.S. would deny that inflation has been strong and rising for more than a year. Heck, it has been a theme of mine since the summer of 2020. As usual, the Fed has been behind the curve, insisting that it was “transitory”, whatever that really means. Powell & Company assured the country that it was nothing to worry about. That kind of reminded me when Ben Bernanke was confident that the subprime mortgage crisis would not lead to contagion elsewhere in 2007. Ben was wrong. Jay was wrong.
Over the past 6 months, almost every inflation report has been greeted by a yawn from the financial markets. Bonds would rally. Gold and the dollar would not do much. Stocks usually rallied. Remember, it’s not what the news actually is, but how markets react. The reflation / inflation / reopening trade in stocks had two noticeable peaks in the summer and fall 2021. Bonds yields actually peaked last March.
In late October with the good folks at Yahoo Finance I offered a very different thesis than I had in well over a year. Inflation was about to begin the topping process. In other words, I said that between November 2021 and March 2022 we would see inflation peak for the cycle. That was a very anti-consensus view shared by few and a high conviction call for me.
Nothing in Friday’s data makes me waver one bit. Inflation is peaking. While I do not believe we will see sub-2% in 2022 like we did for so many years post-2008, I do believe there will be a new floor with a 3 handle, whether that is all the down to 3% or somewhere in the mid to upper 3%s. One of my main themes for 2022 is that inflation trends lower throughout much of the year and the Fed is once again fighting a battle that doesn’t exist.
By the way, how did markets respond to the highest inflation since 1981? The S&P 500 soared to an all-time high. Bonds yields barely moved. That is not the reaction of markets that are supremely concerned about runaway inflation.
Monday’s stock market pullback did not engender thoughts of sugar plums and holiday cheer. A few days earlier I wrote that the bulls best not fail here. Well, the S&P 500 listened well, but the rest of the indices have not, at least not yet. The small and mid cap stock as measured by the Russell 2000 and S&P 400 are supposed to be leading. Yet, they are more in danger of making a new low for Q4. In fact on a day when the S&P 500 hit a new high, the Russell 2000 was actually down on the day. That’s not exactly the healthiest of markets and behavior that needs to change quickly.
The markets are also in a very strong seasonal period. Stocks should be rallying with the small and mid caps leading and doing well. The last catalyst of 2021 is the Fed meeting which starts today and ends on Wednesday. Perhaps the bulls are waiting to get passed that before stepping in again. Bulls surely do not want to see stocks fail to rally into year-end.
