Simple math suggests that tomorrow’s for May will likely continue to show high inflation. To compute CPI, the BLS measures during the first three weeks of the reference month. Thus, May CPI will capture gasoline prices from roughly May 1–21, when national averages were still running at recent peaks. The graph below shows that the highest prices for gasoline futures occurred during the first three weeks of May. The recent easing of gasoline prices will not show up until the June report at the earliest.
It’s worth explaining the math behind CPI and monthly price changes. Gasoline accounts for roughly 3.5% of the CPI basket. Thus, a 10% increase in gasoline prices adds approximately 0.35% to the total CPI. When prices surge by over 40%, as they have recently, gas prices have a significant impact. But, importantly, CPI math works equally powerfully in reverse.
Bond investors, who drove yields sharply higher on energy-related inflation fears, appear to be sensing that the worst may be behind us. Long yields have begun to stabilize even as CPI and CPI forecasts remain elevated. This is a signal that fixed-income investors are starting to look through the current data toward how the math might impact CPI in the opposite direction in the coming months.
Bear in mind, it’s not just falling energy prices that will reduce CPI. Flat over a month will produce a zero percent monthly contribution from energy to CPI. If oil prices ease modestly from current levels, as they have recently, the energy component becomes a disinflationary force in this summer’s CPI reports. To wit, consider that gasoline futures prices imply a decline by about 20%, from $3.15 to $2.50, by year’s end. Per the math, that would reduce CPI by 0.70%.
Sell Off Or Rotation?
We received a few emails over the weekend asking what caused the sharp decline in the markets on Friday. The easy answer is that some of the technology stocks that were soaring had a correction. That is partially correct. The top two screenshots from SimpleVisorAI (coming soon) also tell the story of a massive rotation that occurred on Friday. The market style grid shows that large-cap growth stocks were down nearly 3x as much as large-cap value stocks on Friday. Similar discrepancies occurred across mid and small-cap stocks. Below it, notice that five sectors were higher on the day, despite the S&P 500 closing lower by 2.5% and the by more than 5%.
The second graphic, the heat map, paints a similar picture. Note how many stocks were green or yellow, denoting they were up or flat for the day. The heat map and style grid have shown significant dispersion over the last few weeks. Friday’s activity was similar, but with the laggards winning and the outperformers lagging.
The third graphic shows that the relative and absolute scores for utilities and technology trended in opposite directions over the last two weeks. The technology sector, which had absolute and relative scores in the 80s and low 90s, corrected sharply, almost solely due to Friday’s decline. While the sector remains overbought, it is far more stable than it was late last week. The question we need to ponder is whether the rotational correction was a restbit in the outperformance of technology versus most other sectors or a turning point.