The stock market was rattled this week on the release of April’s inflation data. Consumer price inflation (“CPI”) for the month of April came in at 4.2%, which was more than expected. As a result, stocks dropped on the news as investors became more cautious and rotated out of stocks with high valuation multiples. While Federal Reserve officials continue to say that any increase in inflation is temporary, the activity for the week could be a foreshadowing of the weeks and months ahead. The market is very focused on inflation as one of the primary risks and any upside surprises are likely to spook investors. Here is a look at what is really happening in inflation.
April’s 4.2% jump in CPI was at least partially due to the year over year comparison to 2020. It is important to remember that the comparison year was filled with the tremendous economic strain of lockdowns and falling prices. As a result, year over year comparisons should be tempered since they represent some normalization of the data after a distorted 2020. The Federal Reserve argues that inflation will decline in the coming months as the impact of this prior year distortion diminishes.
However, there are still some troubling numbers in the inflation data. Used car prices for example surged 21% year over year. Gasoline is up 49.6% and Airline fares 9.6%. Major appliances surged 12.3%. Furniture and Bedding rose 7.8% and Sporting Goods rose 7%. While it could be argued that the surge in used car prices is due to a Covid related shift away from public transportation, and the spike in Gasoline and Airline fares could be due 2020 distortions, the surge in Appliances, Furniture, and Sporting Goods are tougher to explain. It is likely that the surge in these prices is due to strong consumer demand, driven by stimulus dollars pouring into the economy.
Which bring us to the most troubling issue: commodity prices are going through the roof in almost every area. Consumer demand appears to exceed supply in many industries, resulting in a 549% increase in the price of lumber, 240% increase in the price of steel, 125% increase in the price of copper just to name a few. It is hard to argue that all these increases are due to the 2020 distortion. The prices paid index for manufacturing rose to 89.6, the highest reading since July of 2008.
The coming months will be critical as the market sorts out what is really happening with inflation and the trend becomes clearer. The economy is hot right now, perhaps too hot. We will continue to evaluate what is happening in the economy and we remain cautious about the potential impact that inflation will have going forward.