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You’re almost certainly too worried about inflation. I acknowledge that my contrarian position on inflation is becoming increasingly solitary. Even U.S. Federal Reserve chairman Jerome Powell, who had been solidly in the “inflation is transitory” camp, threw in the towel at this week’s meeting of the Fed’s Open Market Committee — along with most other members of that Committee as well.
I nevertheless am sticking with my contrarian position because of how Wall Street behaved on two recent occasions. The first came on Dec. 10, as the U.S. Labor Department reported that the Consumer Price Index inflation is running at a 6.8% annual rate, higher than what economists polled by MarketWatch had expected and the highest since July 1982. Yet almost immediately following the release of this inflation news, S&P 500
SPX,
e-mini futures rose 0.5%.
This move higher occurred on heavy trading volume, and it’s impossible to ascertain the motives and beliefs of the individual futures traders who bid up the S&P 500 futures on Dec. 10. But the suddenness of the price increase immediately after 8:30 a.m., and the absence of any other major news at that hour, points overwhelmingly to the inflation news being the catalyst for the market’s rise.
This reaction was surprising, to say the least. The news media over the past six months has been obsessed with whether inflation’s spike is more than temporary, and with how persistent inflation would cause the Fed to tighten more aggressively. In contrast, Wall Street’s reaction to the inflation news suggests that it’s not that worried.
The second occasion on which Wall Street indicated it’s not particularly concerned about inflation came in the wake of the Dec. 3 jobs report, a week prior to the release of the latest inflation data. Even though the Labor Department reported that far fewer jobs were created in November than had been expected, stocks rose: over the 60 minutes following the Labor Department’s release, December S&P 500 futures added 0.5%.
You easily could have imagined the market reacting differently. It seems plausible that a softer economy would prompt the Fed to pursue more inflationary policies. If Wall Street was as anxious about higher inflation as the news media would have you believe, this jobs report would have sent stocks into a tailspin.
That it didn’t react that way suggests that the “market is less worried about long-term inflation,” Ravi Jagannathan, a finance professor at Northwestern University, told me in an email. That’s “good news.”
I reached out to Professor Jagannathan because he co-authored a unique study many years ago on how to interpret the investment significance of the monthly jobs numbers. That study, entitled “The Stock Market’s Reaction to Unemployment News: Why Bad News Is Usually Good for Stocks,” was published in the Journal of Finance in 2005. His co-authors were John Boyd, a finance professor at the University of Minnesota, and Jian Hu of Moody’s Investors Service.
Difference between consumers and professional forecasters
Wall Street’s sanguine reaction to these early-December reports on inflation and jobs is echoed in the strikingly different inflation expectations of consumers, on the one hand, and professional forecasters on the other.
According to the latest survey conducted by the University of Michigan, the median expected rise in the CPI over the next 12 months is 4.9%. In contrast, according to the latest Survey of Professional Forecasters conducted by the Philadelphia Federal Reserve, the median expectation for 2022 is that the CPI will rise 2.4% — less than half of what consumers are expecting. The professional forecasters’ expectation is in the same ballpark as a quantitative model created by the Cleveland Federal Reserve, which is projecting that the CPI over the next 12 months will rise by 2.62%.
Moreover, the Cleveland model is expecting inflation to be lower in 2023. Their model currently is projecting a two-year CPI increase of 2.05% annualized. To get a two-year rate that low, when the first of the two years is experiencing 2.62% inflation, the CPI in 2023 would have to rise by around 1.5%.
Yet another straw in the wind that inflation’s recent spike may be transitory is how the Cleveland model’s projection of 10-year inflation changed in the wake of the Dec. 10 inflation report. Believe it or not, it went down, however slightly, — to 1.75% from 1.76% annualized.
The bottom line? The inflation surprises of 2022 and 2023 are more likely to be on the downside than on the upside. Plan accordingly.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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