What’s causing the current market volatility - and is it here to stay or not?
The stock market has given back some of its early 2023 gains over the past few weeks, so I wanted to share my two cents on why and what might be next.
Short-term traders out, long-term investors in?
After a pretty hot start to the year and a solid run off the bottom in October, it’s pretty natural to give some of those gains back. While it’s going down, it’s often down a little, sideways, up a little, sideways, and we call this consolidation. Getting out shorter-term traders while allowing longer-term investors to step in and buy - hopefully, the market can resume higher. The telling sign will be if those longer-term buyers don’t step in, it could be down or sideways for longer. But all-in-all, we believe the longer-term trend should remain intact.
The green line represents this trend in the S&P 500 chart below.
Another reason for the pullback in equities is refreshed fears of higher inflation for longer; which would mean higher interest rates from the Federal Reserve for longer.
We have seen quite an increase in interest rates and the dollar over the past month. We’ve talked about this nonstop through 2022 and in our 2023 Market Outlook - how I felt the dollar was the key driver, with rates a close second. The move in those two assets is because of inflation and Friday’s inflation number has spooked the market a little. CPI (consumer price index) rose 0.5% in January versus the 0.4% expected. This has caused the market to reduce risk a little, and therefore, stocks have fallen.
In my opinion, I believe this fear is a little overblown.
First, did anyone think inflation was going to go straight down over the next couple of years and never be higher than what the market expected in a given month? I sure didn’t expect that. As with any economic data, it never moves in a straight line, this will be no different. Let’s peal back this CPI onion just a little…
Raoul Paul of Global Macro Investor sent out his chart in his weekend update, which I thought was very interesting. It shows the Case Shiller National Home Price Index YoY% (year over year change) versus the CPI of just Shelter YoY% change. The key in the chart is that Case Shiller has been pushed ahead 15 months. You can see both lines move with a pretty good correlation to one another when they are offset by this length of time. This would suggest CPI for Shelter will follow pretty closely to what Home Prices did 15 months ago. So with home prices falling steadily today, in 15 months’ time, we’d expect shelter inflation to do the same.
While not guaranteed, the data strongly supports this.
But why is this one metric such a big deal to overall inflation?
Because Shelter Inflation represents 34% of total CPI. One-third of the total number comes from this one data point. If shelter CPI ends up following home prices as it has consistently done over the past 30 years, due to its large, one-third weighting in overall CPI, we expect total inflation to follow suit. I strongly believe this was a hotter month in what will continue to be a cooling of inflation over the course of 2023.
Raoul said it really well in his letter - everyone wants to talk about inflation being “sticky”, when in reality, the number is just lagging. In this case, shelter inflation lags home prices by 15 months. Some of this stuff is just harder to reverse than others. Whether it’s inflation, compounding, savings, etc, it’s important to remember, this a long game we’re playing.
Talk soon!
Shean
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.