To my clients:
It was a down week for North American stock markets with the Canadian TSX falling 2.5%; the U.S. Dow Jones Index down 4.6%; and the U.S. S&P 500 down 5.1%.
As I foreshadowed in last Friday’s update, the big economic data release this week was this morning’s Consumer Price Index reading on inflation. The report was broadly disappointing (although I will highlight a nugget of optimism masked by the disappointing headline print). So let’s get to it…
Defying projections that it would plateau at the 8.3% annual pace from April, and likewise moderate from the 0.7% month-over-month reading, headline inflation instead accelerated in both year-over-year (8.6%) and month-over-month (1.0%) terms. Food and energy were once again the major drivers of the high headline print.
That's the bad news and it was certainly poorly received by already unsettled markets. However, here is where the nugget of good news enters the equation. “Core” inflation (i.e. stripping out energy and food costs) actually moderated slightly to 6.0% year-over-year from a 6.2% year-over-year pace the month prior. Undoubtedly food and energy prices matter, and these are probably the most painful portion of inflation for most consumers (yes, my hand is raised here), but to my eye it’s encouraging to see a second consecutive month of slower acceleration in core prices. Remember that the food and energy components are disproportionately affected by the Russia/Ukraine madness, and I’d argue that the rise in prices in these components are not as “structural” in nature as the broader rise in goods prices. Again, I’m moderately encouraged by the slowing in year-over-year price gains in core inflation.
But let’s not sugar coat the situation: inflation – particularly headline inflation - remains high and will need to moderate substantially before markets can find solid footing to sustainably recover on a go-forward basis. That said, I continue to think we are close to that point. Higher interest rates suffer from about a 6-month lag before they begin to slow the economy. While the U.S. Federal Reserve only began raising rates back in March, it should not be overlooked that bond rates began rising well ahead of that time (December of 2021 in fact) as markets anticipated the Fed rate increases to come. Those bond rates reflect the true borrowing costs to most consumers and businesses and we are nearing the point (i.e. roughly 6-months) where the slowing impact of those higher rates should begin transmitting to the real economy.
I’ll conclude by noting that RBC’s 7-point recession scorecard continues to forecast low odds of recession. Admittedly, one of the indicators (the least prescient of the 7 mind you) has slipped to amber status from green, but six green and one amber indicator on our proprietary scorecard remains a very high aggregate reading by any historical measure. We continue to advocate giving equities the benefit of the doubt.
That’s it for this week. All the best,
Nick
Nick Scholte, CIM, FCSI
Senior Portfolio Manager
Scholte Wealth Management
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