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The charts and themes from the past week that tell an interesting story in markets and investing…
1) The Core Problem
Core inflation in the US rose to 6.7% in September, its highest level since 1982.
That fact overshadowed the headline CPI number which moved down to 8.2%, its 3rd straight monthly decline.
What’s driving core inflation higher? More than anything else, Shelter, which at one-third of CPI is by far the largest component. The 6.6% increase in Shelter CPI over the last year is the biggest we’ve seen since 1982.
As I’ve noted several times over the past 18 months, true housing inflation has been wildly understated by the wonky CPI calculation, and now finally appears to be playing catch up. This creates an interesting situation where actual home prices and rental increases are decelerating on a year-over-year basis while the lagging CPI Shelter component is still accelerating.
Where the two will meet remains to be seen, but for now the rising core number remains a thorn on the side of the Federal Reserve, who is expected to hike rates by another 0.75% when they meet in early November.
2) An Untenable Situation
The primary reason why the Fed must continue to tighten policy remains the yawning gap between wages and inflation. Wages have now failed to keep pace with rising prices for a record 18 consecutive months, an untenable situation.
The 14% increase in wages since February 2020 has been a mirage, for if you adjust for higher prices wages have actually fallen.
What are workers doing to try to counteract this? They’re finding new jobs with higher pay. Workers who switched jobs received pay increases of 7.1% over the last year vs. 5.2% for those who stayed at their jobs. With data going back to 1997, this is the widest gap we’ve ever seen.
Speaking of higher pay, the 65 million Americans collecting social security will receive an 8.7% increase in their monthly benefits starting in January 2023. This is the biggest percentage increase we’ve seen in a calendar year since 1982.
3) Savings Less and Borrowing More
In nominal terms, US Retail Sales still appear to be strong, rising 7.8% over the last year. But after adjusting for inflation, the story changes. Real Retail Sales peaked in March 2021 and are down 0.4% over the last year.
The question many keep asking given the wide gap between wages and inflation: how has the American consumer been able to maintain their spending?
The answer: they are saving less (lowest savings rate since 2008) and borrowing more (highest increase in consumer credit since 2011).
Needless to say, this trend cannot go on forever, which is why bringing down the rate of inflation remains critical to the long-term health of the economy.
4) The One Bright Spot
Speaking of the economy, the labor market continues to be the one bright spot. The US Unemployment Rate moved back down to 3.5% in September, tying pre-pandemic levels for the lowest rate we’ve seen since 1969.
Importantly, this number gives the Fed additional room to keep hiking rates as this is about as close to “maximum employment” as you can get.
And the bond market continues to adjust to this reality, with 1, 2, 3, 5 and 10-year Treasury yields all above 4% for the first time since October 2007.
The dramatic rise in yields this year has caused significant pain for bondholders, with the 18% decline in 10-Year Treasury Bond on pace for the largest annual decline ever.
5) Getting Closer to the Median
The stock market declines have deepened as well, with the S&P 500 now 28% below its peak value from 9 months ago. For comparison, the median bear market since 1928 fell 29% over 12 months. It’s important to note, however, that recessionary bear markets have tended to be longer and deeper, with a median decline of 39% over 16 months.
6) Mortgage Pain Continues
But are we in/entering a recession? While the debate continues, the evidence suggesting we are continues to build, particularly in the housing market.
The US Housing Market Index (measure of homebuilder confidence) fell for the 10th consecutive month in October to its lowest level since May 2020.
What’s driving this rapid decline? The rapid rise in mortgage rates which have moved up to 6.92%, their highest level in 20 years.
The lack of affordability is translating into plummeting demand, which is in turn leading to lower prices. Nearly 8% of US homes for sale have cut their asking price over the last 4 weeks, the highest percentage we’ve seen since Redfin started tracking the data in 2015.
7) 2 Signals of Lower Inflation Rates to Come
Global container freight rates hit a 21-month low last week, down 68% from their peak.
Used car prices are now down 10% over the past year, the largest YoY decline on record with data going back to 2009.
Freight rates and used car prices were both leading indicators of higher inflation rates in 2020 and their current downturn is likely indicative of lower inflation rates to come.
And that’s it for this week.
Have a great week everyone!
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