Stock Market Has Two Fears

The stock market may need to get through two fears before moving up again -- fear that the recent high inflation prints won't be temporary and fear that economic growth will slow sharply.  Both fears are probably overdone, but may take more evidential support to become subdued.  In particular, commodity prices need to continue to fall, while economic evidence remains strong.

There is little question that the latest high CPI print was largely a result of just a few items.  Two-thirds of the 0.9% m/m jump in the June Core CPI were accounted for by 4 components -- Used Cars, Hotels, Airfares and New Vehicles.  Their large increases can be explained by chip shortages, higher oil prices and an adjustment to the economy's reopening.  All these factors are likely temporary, but could take time to unwind.  For example, once the chip shortage ends, Used Car Prices will likely fall.

Regarding the overall CPI, food prices surged 0.8% while energy prices jumped 1.5%.   Higher transportation costs could have been behind the jump in food prices, at least in part, reflecting a pass-through of higher gasoline prices and higher truckers' wages (stemming from labor shortages, in part, possibly due in part to the disincentive effect of extended unemployment benefits).   Oil prices now appear to be stabilizing after OPEC agreed to a production hike.  So, their impact on inflation should abate in coming months.  The higher food and energy prices are probably behind the drop in the Mid-June University of Michigan Consumer Sentiment Index.  They hurt consumer purchasing power.  For example, the $15/bbl run-up in oil prices since March, if fully passed through, was equivalent to a $100 Bn tax hike (annualized) on the consumer.  

So far, the US economy looks to be growing above trend, although to a lesser extent than in H121.  Data in the first week of August -- July Employment Report and July Mfg ISM -- could be important evidence to this effect.  Unemployment Claims have resumed their downtrends, consistent with above-trend growth.  If they fall further in the next couple of weeks, they will point to a strong July Employment Report.  The latest manufacturing surveys were mixed, with Phil Fed Mfg Index down (but still at a good level) and NY Empire State Mfg Index up to a new high.  While none of these regional surveys is a reliable predictor of the Mfg ISM, the Empire State has done a better job than Phil Fed so far this year.

Weakness in manufacturing appears to be related to shortages, particularly chip shortages for the motor vehicle industry.  The 0.1% m/m decline in June Mfg Output (in the Industrial Production Report) was largely due to a drop in Motor Vehicle Assemblies.  Ex Motor Vehicles, Manufacturing Output rose 0.4%, the same as the average pace over the first 5 months of the year -- and a very decent pace from an historical perspective.   The chip shortage is setting up the motor vehicle industry for a major rebound in output at some point.