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Inflation A Cure For Lack Of Breadth? Thumbnail

Inflation A Cure For Lack Of Breadth?

Market Musings

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group


The inflation data for June was released this week and it showed that consumers are getting a break in costs.  This caused a shift in the narrative as Mega Cap stocks have been out of favor the last couple of days and Small-to-Mid-caps have been more in vogue.  This week's musings are inspired by a Summer song released in 1971, "Won't Get Fooled Again" by The Who.  The song was a top ten hit for the Who and has been covered multiple times over the years.  Here's some trivia about the song:

  • This song sold more than 500,000 copies (a lot by 1970s standards) and is certified gold.  The song reached #9 on both the U.S. and U.K. charts.

  • The version of this song on the album, "Who's Better, Who's Best," runs 8 minutes and 30 seconds. However, the single version for was cut to only 3 minutes and 35 seconds for air play. Roger Daltrey was not pleased about the editing and regularly complained about the reduced time. In fact, after the editing on this song, The Who focused more on live albums and less on individual singles.

  • Pete Townshend wrote this song about revolution and the need for change in politics, hence the lyric, "Meet the new boss, same as the old boss."  Townshend wrote this song as part of his "Lifehouse" project to produce a rock musical movie about revolution, but that project never really got off the ground.

  • The scream by Daltrey in the middle of the song is considered one of the best on any rock song.  It was so convincing that the rest of the band, having lunch in another room, though Daltrey was brawling with an engineer while recording his lyrics.  The "scream" is used on the recent hit movie "Top Gun:  Maverick" during the infamous training scene.

"A change, it had to come
We knew it all along
We were liberated from the fold, that's all
And the world looks just the same
And history ain't changed
'Cause the banners, they all flown in the last war

I'll tip my hat to the new Constitution
Take a bow for the new revolution
Smile and grin at the change all around
Pick up my guitar and play
Just like yesterday
Then I'll get on my knees and pray
We don't get fooled again, no, no"

Here's what we've seen so far this week...

Shift In Inflation - Shift In Markets?  Inflation came in much better than expected for June and it's having an effect on equities, so far.  The market was expecting the Consumer Price Index to come in at +0.1% for the month of June, which would have been an increase over the 0.0% May reading.  Instead, CPI came in at -0.1%, which markets largely cheered.  While some categories within the CPI did increase in June (Food away from home, Rent, Natural Gas), other key categories that have been stubbornly higher declined or were flat (Physicians' Services, Baking Products, Fruits & Vegetables).  All-in-all, it's a much needed relief for consumers.  The futures on the first rate cut by the Fed, projected to be in September, just skyrocketed.  One month ago, a 25 basis point rate cut by the Fed in September stood at about 60%.  After yesterday's inflation report, futures now stand at an 88% probability of a September rate cut.  This has caused a shift in asset classes over the past couple of days.  Mega Cap Tech names have been in vogue for quite a while now and the differential has been causing an imbalance in this current bull market.  Yesterday, the Russell 2000 Index (small caps) had it's 2nd largest single day out-performance versus the S&P 500 Index in the last 24 years.  In addition, while the Russell 2000 Index was up more than 1% yesterday, the Nasdaq Composite (tech-heavy) was down more than 2%.  So far, this shift from in-favor assets to out-of-favor assets has continued today.  In fact, markets have been dealing with broad indices being driven higher by only a few names for several months.  Yesterday, that changed as US equities saw a massive move higher in the number of stocks making new highs.  It's a good start, but we need to see more improvement in market breadth, which would be a healthy sign for continued strength in the current bull market.  For now, we can revel in the words of Mr. Townshend, "A change, it had to come, We knew it all along."

Soft Landing Achieved?  The first round of 2nd quarter earnings are out for a few of the Big Banks and the numbers are solid overall.  J.P. Morgan, Wells Fargo, Citigroup, and Bank of NY Mellon all beat earnings expectations for Q2.  All but Citigroup also beat on revenue forecasts.  This would indicate solid growth by some of the largest institutions in the country.  The Fed's GDPNow estimate for 2nd quarter is back up to +2.0% after moving lower over the past couple of weeks.  The consumer spending component had moved lower in the Fed's model, however, spending seems to still be on track.  There does not appear to be any drop off in the Redbook Sales data as growth continues trending higher +5% on average year-over-year.  The Financial Stress Index continues to trend lower, meaning that financial conditions are loose.  Prior to previous recessions, the Financial Stress Index tends to move into positive territory 6 to 12 months before the recession begins.  The Fed's National Financial Conditions Index shows that 95 out of 105 contributors to the index are "looser" than average.  Today, J.P. Morgan's CFO, Jeremy Barnum, stated that he believes the economy is "on trend for a soft landing."  If that is the case, which the current data seems to support, we have to ask ourselves what happened the last time the Fed cut rates with no recession.  We have two instances to go by - 1995 and 2019.  In 1995, the Fed cut rates 3 times (25 basis points each cut) with no recession.  In 2019, the Fed did the same - 3 rate cuts of 25 basis points each.  We did have a recession in 2020, the following year, but that did not occur due to eroding economic conditions, but by a pandemic that was self-inflicted.  Regardless, in both instances, equities were largely higher across the board.  For now Mr. Townshend, we defer to your words of wisdom, "And the world looks just the same, And history ain't changed."

We won't get fooled again, or will we...
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