Buying when things are 50% off can feel like you’re stealing. Buying when things are 50% higher and it feels like you’re getting robbed. Inflation sucks. It’s the reason why consumer sentiment is at an all-time low.*
On Thursday I paid $3.54 for a 12-ounce cup of coffee from Starbucks. This one stopped me in my tracks. I remember, because it wasn’t too long ago, when this cost under $2. I know we joke about coffee ruining retirement, but this is no joke. Five cups a day would cost you $90 a week, which would run you $4,600 a year. If instead, you invested that money and earned 40% a year for twenty years, you would have over $13 million.
Anyway, on Friday night I went to the movies to have a date night with…myself. My wife ordered from Seamless (Grubhub). She got a greek salad with chicken, extra feta, and a side of tzatziki. Below is the receipt. Forty freakn dollars. For a salad. With chicken.
I’m not surprised that sentiment is in the toilet. And I’m not surprised that the stock market is right there with it.
I know stocks don’t love inflation, but it’s been a while since I looked at the numbers so I decided to plot CPI with the y/o/y change in the S&P 500. I was mildly surprised with what I found. There’s really no discernible pattern between inflation and the stock market, at least when you plot it like this (the black dot is where we are today).
There’s a lot of noise in this chart. Most of the readings in this chart tell you nothing because when inflation is in the low single digits, there are other factors that weigh more heavily on the stock market. But there is a tipping point where inflation becomes the tail that wags the dog.
70% of the time, inflation is less than 4%. The S&P 500 has historically done quite well when that was the case. Once you get in the 4-6% range, average returns decrease significantly, and keep in mind I’m using nominal numbers. So if the S&P 500 averages 7.6% when inflation is between 4 and 6%, if you’re at the upper end of that range, real returns are pretty measly. Once you get in the 6-8% range on inflation, real stock returns were deeply negative.
There’s a level at which inflation starts to become a bigger part of the picture, but even more important than that is whether inflation is rising or falling. 6% inflation tells you that inflation is high. 6% down from 8% tells you that inflation is high but falling, which the market likes.
When the level of inflation (CPI) is down from the prior year, the average return for the S&P 500 is 12%. When inflation is rising, the average return falls to 6%. That’s a giant difference.
I think that inflation is the only thing that matters right now to the stock market, and the bond market for that matter. Bad economic news will be warmly received by investors as it indicates that the slowdown in demand should bring down prices.
Ben and I were talking on Animal Spirits last week about whether or not the stock market will sniff out peak inflation. Maybe I’m reaching here, but you could make the case that it already is. Alcoa and Freeport, two highly cyclical names that should in theory be correlated with inflation, have given up most of the relative outperformance over the past few months. Commodities relative to stocks peaked a few weeks ago as well, but that trend is innocent until proven guilty, so we’ll see on that one.
The stock market is a complicated beast. Most of the time I’m of the opinion that you can give someone the economic data for the next twelve months, and they wouldn’t know how to profit from it. But that’s when times are normal, and nothing is normal about the current environment. Right now the stock market is pretty damn simple, and the only data point I need for the next twelve months is inflation. If it’s going down, stocks look mighty attractive. And if inflation keeps rising, then it’s a lot more difficult to make that statement. Prices need to come down for stocks to go back up.
*We had raging inflation for a whole decade in the 70s. Why is sentiment lower now than it was back then? I don’t know, but it’s a good question. Maybe it’s the way the survey is taken. Maybe people were tougher back then. I don’t know.