On Friday the latest consumer inflation data came out with inflation at 8.6 percent as measured by the Consumer Price Index (CPI). This was above the 8.2 percent consensus expectation. More importantly, the 8.2 percent expectation represented a continual deceleration in the rate of inflation. Three readings ago inflation had been 8.5 percent, then dropped to 8.3 percent. Now it is at a new short-term high, and this has spooked the market.
In essence this new data has thwarted another attempt at a recovery and put the market back to the previous bottom. We are once again at an important inflection point: Will the bottom hold and the recovery resume, or will we break through and continue to decline? Frankly it could go either way in the short term. We will be watching closely and are prepared to take further protective measures.
In the longer term it is hard to envision the market not being higher one year from now. The fact remains that we are near full employment and most companies have reported good earnings. So why does inflation have the market so nervous?
It isn’t really inflation that scares the market, it is the Federal Reserve’s (Fed’s) reaction to inflation that scares the market. Market participants fear that the Fed will put us into a recession in their effort to get inflation under control. Market participants are now betting on at least one 0.75 percent raise in rates by the Fed, according to futures markets. These markets have been notoriously bad at predicting actual Fed policy, but that never seems to matter to short-term traders.
In anticipation of these rate hikes (which have not happened and may not happen), The Financial Times reports that 70 percent of academic economists predict we will be in a recession by next year. Will that happen? The key to the recession question is employment. As of this moment the job market is extremely strong and has not shown any signs of weakening. That is the key indicator that we will be following.
These times are always difficult. It is painful and can cause stress, and we understand that. There is one silver lining which may not seem like much now, but in the long-term really matters: The defensive measures we have taken thus far are working. We are not immune to the market, but across the board our strategies are losing less than the market. This matters when the rebound eventually comes, and it will come.
We may still have to take further action in the short term, and if we deem it necessary, we will do so. One simply cannot fight the market. Having said that, we do believe that the market is currently overly pessimistic. Markets overreact; that is what they do. This too shall pass, and we will get through it.
Warm regards,
Chuck Osborne, CFA
Managing Director
