Price Pain, but No Sticker ‘Shock’ to Stocks

The results are in, and as widely expected, US inflation wasn’t pretty in April. The headline Consumer Price Index (CPI) rose 3.8% y/y, up from March’s 3.3% and the fastest rate in three years.^[i] Fuel prices drove the jump, and Americans took an inflation-adjusted pay cut as real wages fell. Ouch and ouch. But despite this objectively bad news, for markets, nothing really changed. Data are merely confirming what stocks already anticipated, priced and seemingly got over as they fell in March and rallied in April. Always think like markets, and don’t get hung up on short-term data wobbles.

Note, we aren’t dismissing the pain evident in April’s report. The pangs at the pump (28.4% y/y) are real.^[ii] So are higher meat (8.8% y/y) and fresh food and vegetable (6.5%) prices, jumpy air fares (20.7%) and the jolt in household energy prices (6.5%).^[iii] It is hard for everyone when the most visible items in the household budget get suddenly more expensive. It is especially so for those on low and fixed incomes, not to mention those who require long commutes to make ends meet. For these folks, it will be cold comfort that core CPI, which excludes food and energy, was milder at 2.8% y/y.^[iv] And that a big chunk of that rise flowed from a one-time adjustment to shelter costs to pave over the missing data from last autumn’s government shutdown. Many will understandably dismiss the fact CPI ex. food, energy and shelter ran a mild 2.3% y/y and just 0.2% m/m.^[v]

But markets are cold-hearted, made of sterner stuff. They don’t care about individual people’s and households’ difficulties. They deal with broad trends and aggregates and, specifically, how those influence corporate earnings over the next 3 – 30 months. So when you look at things like the inflation report and want to determine what they mean for stocks, hard as it is, you have to turn off your feelings. And then ask: Does this report tell me anything new about corporate earnings over the foreseeable future? Does it have bad news above and beyond what headlines already warned me about for months?

Two Nos here will generally mean the report is meaningless for stocks, and we think two Nos are what you get. As soon as the war in Iran began, the Strait of Hormuz closed and oil prices jumped, analysts warned it would lift inflation, starting with fuel-related categories. March’s CPI report registered that. When it didn’t show fresh food prices jumping, analysts warned that would hit soon as higher diesel prices made refrigerated transit more expensive. That happened in April, with assistance from tomato and beef shortages. The negatives in this report aren’t negative surprises, which is what stocks care about.

Also important: What isn’t in this report. So far, we still aren’t seeing second-order oil price effects in inflation. Meaning, goods that use oil or natural gas as feedstock aren’t registering those higher component prices yet—this is where benign prices ex. food, energy and shelter come in. Household cleaning products—heavy on chemicals—fell -0.7% m/m.^[vi] Footwear prices rose 1.4 m/m, but it seems hard to pin this on skyrocketing synthetic rubber when shoes have endured similar one-off jumps in recent years.^[vii] The same goes for cosmetics (many of which include mineral oil, a petroleum derivative), whose 1.3% m/m rise is a whisker above January’s pace.^[viii] Toys’ 0.9% m/m rise slowed from March’s 2.0%, which followed three straight monthly drops.^[ix] That doesn’t seem like a nightmare of soaring plastic prices. To us, it all looks like standard monthly data variability.

Headlines warn these second-order effects are merely delayed. We doubt it. Businesses can pass higher costs to customers only if they have pricing power. Demand must be strong enough to absorb it. That generally doesn’t happen unless broad money supply jumps to lift demand. That happened heading into 2022’s hot inflation, which followed US M4, the broadest measure, soaring past 30% y/y in summer 2020.^[x] In March it grew just 5.8% y/y, in line with prepandemic trends and extending a run of tame readings.^[xi] That wasn’t hot enough to lift inflation broadly. It is a benign growth rate, which means households will probably respond to higher-priced essentials by cutting discretionary spending. When households make those tradeoffs, it saps businesses’ pricing power. You don’t get hot inflation.

As for falling real wage growth, this shouldn’t surprise markets either. Wages always follow price trends at a lag, which is why inflation typically feels so painful. It takes a while for pay to catch up. That was the case in 2022 and its aftermath. It will probably be the case now. But for markets, this is normal and expected. Here, too, the dreary data merely confirm the widespread warnings stocks have dealt with since March.

All economic data releases are backward-looking. We sit here, halfway through May, looking at price movement in April. Markets don’t look backward. They look forward, and we think nothing in April’s CPI report tells you negative surprise looms in that window. Instead, with money supply tame, we think there is a good chance positive surprise awaits, propelling stocks up the wall of worry.