Market Insights: Inflation Slowdown Could Fuel Stocks

Macroeconomic and Market Developments:

• North American markets were positive for the past two weeks. In Canada, the S&P/TSX Composite Index was up 2.33%. In the U.S., the Dow Jones Industrial Average increased 2.79% and the S&P 500 Index advanced 3.63% over the past two weeks.
• The Canadian dollar was slightly positive, closing at 78.26 cents vs 78.13 cents two weeks ago.
• Oil prices were down significantly over the past two weeks. U.S. West Texas crude closed at $91.85 vs $98.06, and the Western Canadian Select price closed at $72.47 vs $77.21.
• The gold price was also positive, closing at $1,800 vs $1,763 two weeks ago.
• Employment numbers for July were released last Friday. In the U.S., nonfarm-payrolls expanded by 528,000 in July, more than double expectations of a 250,000 increase. The unemployment rate fell to 3.5%, marking its lowest level since 1969. For Canada, our economy lost 30,600 jobs compared with the expected gain of 15,000. Canada’s unemployment rate remained at the historic low of 4.9%.
• As has been the case all year, inflation numbers moved markets this week. The U.S. headline Consumer Price Index (CPI) came in at 0.0% from June to July, weaker than the 0.2% increase expected, and down from the 1.3% move from May to June. The CPI for the past year was 8.5%, below the expected 8.7% and down from 9.1% from June 2021 to June 2022.
• Also, the Producer Price Index (PPI), another measurement of inflation, declined 0.5% in July, coming in well below the expected 0.2% gain. Producer prices are up 9.8% compared to a year ago. Core producer prices (excluding food and energy) rose 0.2% in July and are up 7.6% in the past year.
• Cenovus Energy (CVE) has reached an agreement to purchase BP's 50% interest in the BP-Husky Toledo Refinery in Ohio. In addition, the two companies have signed a multi-year product supply agreement.
• Canadian restaurant owner Recipe Unlimited (RECP), with names such as Swiss Chalet, Harvey’s and Montana’s, has entered into a letter of intent with Fairfax Financial to be purchased at a price of $20.73/share in cash. The Offer Price represents a 53.4% premium to the closing price on August 8, and the proposed transaction is expected to close in the last quarter of 2022.
• Earnings releases continued to roll in for Canadian companies this week:
  • Barrick Gold (ABX) reported better than expected earnings of $0.24/share vs $0.22/share expected. Additionally the company announced that it is on course to achieve its annual gold and copper production guidance while continuing to progress its key growth projects.
  • Brookfield Asset Management (BAM.a) reported better than expected Funds From Operations of $0.84/share vs $0.79/share expected, and announced a record of $111 billion of cash and capital available for investment. The company also remains on track to complete its previously announced distribution to shareholders and listing of a 25% interest in its asset management business by year end.
  • Canadian Tire Corp (CTC.a) reported lower than expected earnings of $3.11/share vs $3.60/share expected, on revenue of $4.40 billion vs $4.34 billion expected. Retail revenue was up 12.3% including petroleum sales from a year ago, and up 5.1% excluding petroleum.
  • Stelco Holdings (STLC) reported earnings of $4.93/share, better than the expected $4.49, on revenue of $1.04 billion which matched expectations. The company also reiterated its guidance for Q3 and Q4 of 2022 that expects EBITDA in Q3 will be materially below the Q2 level, and further weakening is expected in Q4 results.
• Here is a link to a short video from Canaccord’s chief U.S. Strategist Tony Dwyer entitled Our Take on Market Ramp: DWYER VLOG

 

Weekly Diversion:

Check out this video of a Bugatti built from Lego.

Charts of the Week:

We will start this week’s Charts of the Week showing the recent and continued surge in insider buying of NASDAQ Composite (NDX) stock positions. Insiders are the executives that actually operate the companies and presumably know the most about what is going on inside those enterprises. History has typically shown that insiders have often been a bit too early, but more often than not, correct on their calls in the long-term versus average returns. Right now insider buying is the highest it has been in at least 12 years. It will be interesting to see down the road if their timing was correct this time.

Source: Jay Kaeppel, SentimenTrader

Our main topic today is the recent decline in headline inflation. On Wednesday, the U.S. Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) decreased from June to July on a year-over-year basis. While inflation as measured in CPI’s change from a year ago or in the last few months versus the few months prior is still very high, the negative inflation print month-over-month, along with a recent decline in the Producer Price Index (PPI), is being seized by markets with a more positive sentiment shift. Could these recent numbers point to the fact that the worst of the inflation pressures has passed? Only time will tell, but U.S. leading indicators for most areas of the market, from services, to autos, to food, to housing & rent and to recreational goods, are suggesting that core inflation pressures are set to slow. As we have noted in past comments, markets move based on expectations and the rate of change, more than the absolute level (market have already priced that part in), so markets will generally take this latest inflation data positively.

Source: Bespoke Investment Group

How would further declines in the rate of change for inflation affect equities? In general, when CPI is decelerating, as the latest numbers suggest and with leading indicators showing it will slow further still, stocks should perform better going forward. The following two charts show that while declines in year-over-year CPI do not lead to massive equity market outperformance, there is clearly a solid benefit to stocks.

Source: Bespoke Investment Group

Lastly, and perhaps most important, is to look at market inflation pricing or ‘breakeven inflation’. Breakeven inflation is the market pricing of inflation based on the yield spread between nominal U.S. Treasury yields and inflation-protected Treasury yields. As we noted above, markets tend to move more on expectations versus what has already occurred. As shown below, when 5-year breakeven inflation rates are more than 0.75% below the 52-week high, as they are at present, forward equity market performance is much higher than other scenarios. While we do not think that the very recent data points of slowing inflation is enough or is the cure all, it will likely improve investor sentiment to some extent. The key will more likely be a pivot in the U.S. Federal Reserve and their current rapid monetary tightening (i.e., rising interest rate policy), which does hurt equities. However, any decline in the rate of inflation should be seen as a sign that monetary policy may be less tight in the future than otherwise would have been.

Source: Bespoke Investment Group

Sources: CNBC.com, Globe and Mail, Financial Post, Connected Wealth, BNN Bloomberg, Tony Dwyer, Canaccord Genuity, First Trust, Bespoke Investment Group, Jay Kaeppel - SentimenTrader