Dear Readers,
Inflation rose 9.1% in June, above the 8.8% estimate by Dow Jones. This is the headline news across the internet tonight.
CNBC: Inflation rose 9.1% in June, even more than expected, as consumer pressures intensify
Reuters: U.S. consumer inflation rises to highest annual rate since 1981
Bloomberg: US Inflation Quickens to 9.1%, Amping Up Fed Pressure to Go Big
Thought I would like to dive deeper into the CPI numbers rather than reading off headlines. Let us look deeper into the data.
Source: U.S. Bureau of Statistics
Lets dive deeper into the data that has been provided.
Food
The food index increase 1% in June following a 1.2% increase in the prior month. Just December 2021, the food index increase only 0.4% from the prior month (November 2021). This is the 6th consecutive months that that the index had rose of at least 1%.
The index for other food at home rose 1.8 percent, with sharp increases in the indexes for butter and for sugar and sweets. The index for cereals and bakery products increased 2.1 percent in June, with the index for flour rising 5.3 percent. The dairy and related products index rose 1.7 percent over the month, following a 2.9-percent increase in May.
The fruits and vegetables index increased 0.7 percent in June after rising 0.6 percent in May. The index for nonalcoholic beverages rose 0.8 percent over the month. The only major grocery group index to decline in June was the index for meats, poultry, fish, and eggs which fell 0.4 percent over the month as the indexes for beef and pork declined.
The food away from home index rose 0.9 percent in June after rising 0.7 percent in May. The index for full service meals rose 0.8 percent over the month. The index for limited service meals increased 0.7 percent in June, as it did in May.
The food at home index rose 12.2 percent over the last 12 months, the largest 12-month increase since the period ending April 1979. All six major grocery store food group indexes increased over the span, with five of the six rising more than 10 percent. The index for other food at home increased the most, rising 14.4 percent, with the index for butter and margarine increasing 26.3 percent. The remaining groups saw increases ranging from 8.1 percent (fruits and vegetables) to 13.8 percent (cereals and bakery products).
The index for food away from home rose 7.7 percent over the last year, the largest 12-month change since the period ending November 1981. The index for full service meals rose 8.9 percent over the last 12 months, and the index for limited service meals rose 7.4 percent over the last year.
Deep Dive – Food
- Though the Food index did rise in June (1%), it is 20% lower than that of what was reported in May (1.2%). The highest this year stood at 1.2% (May 2022). As such, this may be a possible sign that food prices are beginning to stabilize, displaying some form of price easing.
2. The only major grocery group index to decline in June was the index for meats, poultry, fish, and eggs which fell 0.4 percent over the month as the indexes for beef and pork declined. Protein prices have started to pull back for the month of June.
3. Sharp increase in the indexes for butter and for sugar and sweets. The index for cereals and bakery products increased 2.1 percent in June, with the index for flour rising 5.3 percent.
Possibly due to the Russia-Ukraine war and the two countries alone account for 25% of global exports of wheat. Refer to the chart below.
Even if the war is to end, the supply disruption may still persist and supply from these 2 countries will not return into the market as fast as we wanted. As such, I do expect the prices of flour and other food commodities to stay elevated. I believe this will negatively affect the consumers more than the producers as global producers had started to raise their prices and demand remains strong as this is a necessity of life.
4. There were sharp increases in the indexes for butter and for sugar and sweets. Sugar prices has stayed elevated since August 2021 (Refer to chart below). But it has definitely came off a high since May 2022 and whether the prices will stay elevated remains to be seen.
Energy
Refer to table 3 above. It is very clear that energy remains one of the bigger contributor to inflation. On table 2, one can see that over a 12-month period, fuel oil price has increased nearly 100%.
Deep Dive – Energy
As CPI is a lagging indicator, I would have to make some forecast into the future prices of oil. This will allow me gauge whether this big contributor to inflation will show signs of waning heading into the 2nd half of 2022.
Increasing oil supply from OPEC is not something that I will rely on as a lot of times, there is a of talk but usually no action. Of course, we know that they are beneficiaries as a result of high oil prices. Why would I as a producer increase supply to reduce prices and in turn, negatively impact my profitability.
But that been said, with demand expected to weaken in the coming months as recession looms, the price of oil may continue to decline even without the adjustment in supply from OPEC. Most of the time, from what I see, oil has always been a political arena between the west and the middle east.
But from technical perspective, it does seem to me that oil has indeed hit its high in June 2022.
All Items less food and energy
After taking out the two volatile components of food and energy, we see that the All items less food and energy index rose 0.7% with prior month increase of 0.6%. This has been contributed mainly by transportation services (1.3% in May to 2.1% in June), Motor vehicle maintenance and repair (0.5% in May to 2.0% in June), Motor vehicle body work (1.0% in May to 1.8% in June), Motor vehicle maintenance and servicing (0.3% in May to 2.0% in June), Motor vehicle repair (0.7% in May to 2.1% in June), Motor vehicle insurance (0.5% in May to 1.5% in June). For the full list of the items released by U.S. Bureau of Labor Statistics, please download the file below.
Deep Dive – All Items less food and energy
I believe that the continuous rise in the motor vehicle segment like Motor vehicle maintenance and repair , etc is the result of rising oil prices. A number of these products are derived from oil. Moreover, some of these by-products are imported from China and the price increased may be due to the high shipping cost (refer to table 4) and not forgetting the China Covid lockdowns in some cities.
The question to ask is whether the freight cost will stay high going forward into the second half of 2022. With some China cities constantly facing the risk of a lockdown, this is anyone’s guess. But from the technical perspective, it seems that the freight prices may have already seen the high for the year. Of course I would not be able to know whether another wave of Covid infections will hit China again, for the matter of fact, anywhere in the world. But China should have seen its extreme lockdown in Shenzhen, Beijing and Shanghai a few months back. I choose to think that the Chinese Government is more desperate to get its economy back in shape after a major GDP slowdown in 2nd quarter this year.
How did the market react after the released of June’s inflation numbers?
We see the S&P500 opened lower after the released of June’s inflation numbers. It traded in a tight band of 30 points for the first one hour and proceeded to rally higher as the day progressed. As of my writings now, 1.30am Singapore time, the index stayed above the 3,800 level which is 16.6x FPE (based on analysts ‘consensus EPS forecast for year 2022 of US$228.86), which is below the ten-year average of 16.9x. However, it is still above the next three most recent historical averages: 15-year (15.5x), 20-year (15.5x), and 25-year (16.5x).
Assuming S&P500 trades at 15.5x FPE, the level that it would pull back to is 3,547. But this looks like more of an extreme case. In market, there is always a possibility but I would work out the probability as well.
What to do as an investor?
In my opinion, the market will continue to consolidate around the current level of 3,800 as most of the bad news have already been priced in. This can be seen by how the market reacted after the released of June’s inflation numbers. However, there is another piece of unknown which is the mid-term election in November which will keep the market subdued until then.
And historically, post mid-term years are good for investors as the elected party seek to improve economic conditions, pushing out more fiscal policies.
So, I would use a risk-reward matrix to decide whether to position now. Downside risk: 3,547 representing a downside of 6.7% vs an upside potential of 15.8%, with my year-end target of 4,400 for the S&P500. Link to my article here.
Seems like a good trade!
For those who would like a copy of the CPI numbers released by Bureau of Labor Statistics, please find copy attached below. You can click to download.