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Inflation is Slowing, But is it Enough to Slow the Fed? 3 ETFs to Fight Back
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The BLS released the most recent December inflation data Thursday morning. The print was in line with market forecasts showing a modest decrease in CPI. The Consumer Price Index decreased 0.1% in December after increasing 0.1% in November. Over the last 12 months the index is up 6.5%
Core inflation, which is all items on the CPI excluding food and energy increased by 0.3% to come in line with expectations. The 12-month change in Core CPI is now 5.7%.
Investors for now seem to be content with the data. Inflation has slowed for the sixth straight month, after peaking in June 2022 at 9.1%, and is now the lowest it has been since October 2021.
Market Reaction
Not surprisingly the market had a volatile reaction to the print. Everything from equities to bonds, and gold had large whipsaw moves. Although even now, several hours later these markets are mostly unchanged.
Being a highly anticipated data release there were likely many options and volatility traders positioned for the event. It is also likely that there were investors hedging worst scenario tail risks, in case the numbers came back very poor. But because of this anticipation the market will often hurt these traders, and a choppy rangebound market to burn the options premium is likely.
It will take time for the market to digest this information, so extrapolating any immediate reactions can be a risky speculation.
Is it Enough?
I don’t mean to be a doomer, but inflation is cooling very, very slowly. Inflation decreased a paltry 0.1% in December, and Core CPI is still increasing. Additionally, the only components of inflation that significantly slowed were Energy and Used Cars and there were also small decreases in commodities less food and energy, and new vehicles.
The price of food is still increasing over 10% annually, transportation 14% and shelter 7.5%. While we can look at these numbers academically, they are the budgets of regular people. This remains a challenging time for many.
Image Source: US Bureau of Labor Statistics
Historical Context
It can be helpful to look at similar times in history to get a clue on what is happening today. A useful analog for today’s inflation and interest rate environment is the mid to late 1970s in the United States. Like today, the economy experienced tremendous inflation, as high as 12.5%, and a Fed was raising rates in response.
When looking at the inflation chart from this period, we can see there was an easing of inflation starting in 1975, coinciding with a recession. Yet, only a couple years later inflation would come rearing back and make new highs. Can you imagine how the market would react today to something like this?
Image Source: Fred
I am not saying that this is going to happen, but it should be on investors’ radar. All forecasts in the economy happen within a range of possibilities. Furthermore, the current Fed chair Jerome Powell, is a big fan of the central banker Paul Volcker who engineered the slowing of inflation during the 1970s. He wants to make sure the US doesn’t experience a secondary inflationary rally.
To combat the rampant inflation of the time Volcker had to become a very unpopular policymaker. While the Fed has a dual mandate, maximizing employment, and encouraging price stability, Volcker was forced to prioritize inflation. He knew how incredibly destructive it was to an economy, and to do so he raised rates significantly. To quell inflation he raised the Federal Funds Rate in excess of inflation. During the first attempt as high as 12.5%, then to finally end it, he brought rates all the way up to 19%. I don’t know if this will have to happen, but the possibility shouldn’t be discounted.
Image Source: Fred
ETFs to Watch
There are a few places to go if inflation remains stickier than expected. Because the improving outlook on inflation is beginning to lead the market narrative-wise, a reversal of this could really shake things up. If inflation misses future forecasts, or in the worst-case scenario, actually increases again, selling short the stock market would probably be a winning trade.
You can of course strait up short (SPY - Free Report) or another broad market index fund or, you can use an inverse fund. Proshares Trust Short S&P 500 ETF (SH - Free Report) is one such product. In the case of another market sell-off, you can expect SH to perform very well. Because of how these products are structured though, it is important to note that they are not well suited to being held for long periods. They should be used primarily as trading vehicles.
Persistent inflation would likely be a boon to oil and the energy market as well. If inflation remains persistent or does pick up again you can certainly expect energy prices to rise. SPDR Energy ETF (XLE - Free Report) is one effective way to get broad exposure to the top oil and gas companies.
XLE was the best performing sector ETF in 2022, and was up a very impressive 60%. The fund also offers a dividend yield of 3.8%, and its largest positions are (XOM - Free Report) and (CVX - Free Report) , which make up nearly half of the fund.
Lastly, in the goldilocks case, where inflation has peaked and continues to slow significantly, a great place to invest would be technology stocks. The SPDR Technology ETF (XLK - Free Report) , which got hammered in 2022 may be a great investment in that scenario. Many of the companies in this fund were hit hard by rising interest rates, which rerated their earnings multiples.
XLK holds some of the best companies in the world including, AAPL, MSFT, V, and NVDA and currently holds a Zacks Rank #2 (Buy) indicating improving earnings expectations.
Many of these companies have become extremely compelling investments at these levels and Iif inflation has peaked, then interest rates can cool off, and these stocks can lead the next bull market.
Conclusion
I am very happy to see inflation continuing to ease, but the rate of decrease is quite slow. And Core Inflation, arguably the more important figure, is still increasing. Investors should be weary of taking victory laps on inflation. There is still a way to go, and the effect on regular people, the economy and capital markets cannot be overstated. The SPDR
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Inflation is Slowing, But is it Enough to Slow the Fed? 3 ETFs to Fight Back
The BLS released the most recent December inflation data Thursday morning. The print was in line with market forecasts showing a modest decrease in CPI. The Consumer Price Index decreased 0.1% in December after increasing 0.1% in November. Over the last 12 months the index is up 6.5%
Core inflation, which is all items on the CPI excluding food and energy increased by 0.3% to come in line with expectations. The 12-month change in Core CPI is now 5.7%.
Investors for now seem to be content with the data. Inflation has slowed for the sixth straight month, after peaking in June 2022 at 9.1%, and is now the lowest it has been since October 2021.
Market Reaction
Not surprisingly the market had a volatile reaction to the print. Everything from equities to bonds, and gold had large whipsaw moves. Although even now, several hours later these markets are mostly unchanged.
Being a highly anticipated data release there were likely many options and volatility traders positioned for the event. It is also likely that there were investors hedging worst scenario tail risks, in case the numbers came back very poor. But because of this anticipation the market will often hurt these traders, and a choppy rangebound market to burn the options premium is likely.
It will take time for the market to digest this information, so extrapolating any immediate reactions can be a risky speculation.
Is it Enough?
I don’t mean to be a doomer, but inflation is cooling very, very slowly. Inflation decreased a paltry 0.1% in December, and Core CPI is still increasing. Additionally, the only components of inflation that significantly slowed were Energy and Used Cars and there were also small decreases in commodities less food and energy, and new vehicles.
The price of food is still increasing over 10% annually, transportation 14% and shelter 7.5%. While we can look at these numbers academically, they are the budgets of regular people. This remains a challenging time for many.
Image Source: US Bureau of Labor Statistics
Historical Context
It can be helpful to look at similar times in history to get a clue on what is happening today. A useful analog for today’s inflation and interest rate environment is the mid to late 1970s in the United States. Like today, the economy experienced tremendous inflation, as high as 12.5%, and a Fed was raising rates in response.
When looking at the inflation chart from this period, we can see there was an easing of inflation starting in 1975, coinciding with a recession. Yet, only a couple years later inflation would come rearing back and make new highs. Can you imagine how the market would react today to something like this?
Image Source: Fred
I am not saying that this is going to happen, but it should be on investors’ radar. All forecasts in the economy happen within a range of possibilities. Furthermore, the current Fed chair Jerome Powell, is a big fan of the central banker Paul Volcker who engineered the slowing of inflation during the 1970s. He wants to make sure the US doesn’t experience a secondary inflationary rally.
To combat the rampant inflation of the time Volcker had to become a very unpopular policymaker. While the Fed has a dual mandate, maximizing employment, and encouraging price stability, Volcker was forced to prioritize inflation. He knew how incredibly destructive it was to an economy, and to do so he raised rates significantly. To quell inflation he raised the Federal Funds Rate in excess of inflation. During the first attempt as high as 12.5%, then to finally end it, he brought rates all the way up to 19%. I don’t know if this will have to happen, but the possibility shouldn’t be discounted.
Image Source: Fred
ETFs to Watch
There are a few places to go if inflation remains stickier than expected. Because the improving outlook on inflation is beginning to lead the market narrative-wise, a reversal of this could really shake things up. If inflation misses future forecasts, or in the worst-case scenario, actually increases again, selling short the stock market would probably be a winning trade.
You can of course strait up short (SPY - Free Report) or another broad market index fund or, you can use an inverse fund. Proshares Trust Short S&P 500 ETF (SH - Free Report) is one such product. In the case of another market sell-off, you can expect SH to perform very well. Because of how these products are structured though, it is important to note that they are not well suited to being held for long periods. They should be used primarily as trading vehicles.
Persistent inflation would likely be a boon to oil and the energy market as well. If inflation remains persistent or does pick up again you can certainly expect energy prices to rise. SPDR Energy ETF (XLE - Free Report) is one effective way to get broad exposure to the top oil and gas companies.
XLE was the best performing sector ETF in 2022, and was up a very impressive 60%. The fund also offers a dividend yield of 3.8%, and its largest positions are (XOM - Free Report) and (CVX - Free Report) , which make up nearly half of the fund.
Lastly, in the goldilocks case, where inflation has peaked and continues to slow significantly, a great place to invest would be technology stocks. The SPDR Technology ETF (XLK - Free Report) , which got hammered in 2022 may be a great investment in that scenario. Many of the companies in this fund were hit hard by rising interest rates, which rerated their earnings multiples.
XLK holds some of the best companies in the world including, AAPL, MSFT, V, and NVDA and currently holds a Zacks Rank #2 (Buy) indicating improving earnings expectations.
Many of these companies have become extremely compelling investments at these levels and Iif inflation has peaked, then interest rates can cool off, and these stocks can lead the next bull market.
Conclusion
I am very happy to see inflation continuing to ease, but the rate of decrease is quite slow. And Core Inflation, arguably the more important figure, is still increasing. Investors should be weary of taking victory laps on inflation. There is still a way to go, and the effect on regular people, the economy and capital markets cannot be overstated. The SPDR