Two items to cover today:
#1: We have 3 points on June’s US Consumer Price Index, out Tuesday morning.
First: this report will attract significant attention, so let’s review current expectations:
- Headline inflation to rise by 0.7 percent, or +5.1 pct versus June 2020
- Core inflation to rise by 0.6 percent, or +4.2 pct versus June 2020
Takeaway: if both headline and core come through as expected they will be 1) hotter than May’s year over year readings and 2) the highest core inflation readings in the 2000s and close to the highest headline numbers. This chart shows the history:
Second: those are the scary headlines you can expect to read on Tuesday, but let’s remember that gasoline price inflation has been a key driver of headline CPI inflation and the year over year comps are starting to roll over. Gas prices were fully 40 percent of May’s 5.0 percent headline inflation. They’ll also play a role in June’s data, but as the chart here shows the effect is already diminishing (year over year changes in US gas prices, 2000 – present):
As far as core Inflation goes, used car prices have been a key swing factor in recent months (24 pct of May’s 3.8 pct ex-food and energy reading) but the latest readout from Manheim’s Used Vehicle Value Index says:
- “Wholesale used vehicle prices … decreased 1.3 percent month-over-month in June.”
- “… prices saw weekly increases in the first two full weeks of June, but the remaining weeks saw accelerated price declines.
Takeaway: as high as June’s US inflation readings will be, there should not be much new in terms of the ongoing “transitory vs. structural” debate. The pieces of CPI that have been pushing aggregate readings higher will still be present due to easy comparisons (gasoline) and/or oddball items (used car demand due to chip-related new vehicle shortages). We’ll likely also see some Transportation-related inflation (airfares, car insurance, etc.).
Third and lastly: a very strong US real estate market is not yet reflected in CPI, but history shows it does eventually filter into these numbers.
This chart shows the annual change in the Case-Shiller US Home Price Index (black line, right axis), and Owners’ Equivalent Rent/Rent of Primary Residences (red and blue lines, left axis) from 1990 to present. Case-Shiller is showing 15 percent US home price inflation at present. By contrast, OER and Rent were only up +2 percent in May 2020.
Recall that the OER data comes from a BLS survey question which asks homeowners “how much would your house rent for?”, with the Bureau then tracking an index of those responses over time. It is not in any way directly tied to either home prices or interest rates. The CPI did measure “Shelter” inflation that way until 1983 but changed to the OER approach when it was clear that the old methodology was creating sky-high inflation headline/core inflation readings.
As much as it’s hard to square the current Case-Shiller and CPI housing inflation data, this chart shows that there is a noticeable lead-lag effect. Case-Shiller peaked in September 2005 (middle of the chart), and OER/Rent peaked in March 2007. Then, CS troughed in February 2009 but OER/Rent didn’t make a bottom until June 2010.
Takeaway: OER and Rent are the 2 most logical places within the Consumer Price Index to look for structural inflation pressures over the next 12-24 months. Combined, they are 32 percent of headline and 40 percent of core.
- Should the Federal Reserve be worried about this?
- History says “No” – they should actually welcome it.
- For most of the last decade, OER/Rent inflation has been a reliable anchor keeping CPI inflation anywhere near the Fed’s stated goal of 2 percent. From 2011 – 2020, OER inflation averaged 3.8 pct and Rent inflation averaged 3.3 pct, but headline CPI only averaged 1.7 percent.
- In other words, the historical record says the Federal Reserve needs to keep the housing market running hot because there’s not a lot of structural inflation outside of this part of the US economy.
Item #2: Let’s take a fresh look at what we call “the most important chart for the direction of US equity prices”. That honor belongs to the FactSet data which shows Wall Street analysts’ aggregate S&P 500 earnings estimates for 2021 (bottom line in the chart below) and 2022 (top line).
What we’ve done here is split up the last year into 2H 2020 and 1H 2021. As you can see, this year shows a lot more momentum than the back half of last year. The Street was only cautiously increasing its numbers in the second half of 2020, by 2.5 percent for 2021 and 4.3 pct for 2022. As analysts saw first Q4 2020 results and then Q1 2021, the latter of which beat their expectations by a wide margin, they began to raise their current and forward-year estimates more dramatically.
In our mental model of how stocks trade, the change in forward earnings expectations is the most critical driver and there’s really no second place contestant. We are hearing more concerns that the US/global economy is at “peak growth” just now, and that may well be true. But if the companies of the S&P 500 can continue to generate earnings meaningfully ahead of expectations, that doesn’t matter just yet.
Takeaway: Q2 US earnings season should keep giving analysts and investors confidence that corporate earnings expectations can continue to rise. Put another way: the upcoming earnings season needs to be a blowout to the upside – at current prices nothing less will make for further gains.
Manheim Used Vehicle Data: https://publish.manheim.com/en/services/consulting/used-vehicle-value-index.html