On September 13, August's US Consumer Price Index (CPI) numbers were released. Inflation had been widely viewed as moderating, but the actual number exceeded expectations.
This sparked fears of even more aggressive actions by the Federal Reserve. As a result, the market is now pricing in an almost certain Fed Fund Target Rate increase of 0.75% on September 21, raising the possibility of an even more drastic 1.0% increase. US equity markets responded with a chaotic sell-off. The S&P500 index ended the day at -4.3%.
Investors should take a deep breath and ignore the rout for three reasons.
Long-Term Focus Always Pays Off
In the short term, markets defy logic and tend to trick investors. When investors feel most compelled to sell to limit losses, markets bounce. When they are most enthused and buy, markets fall. So, the most sensible, although challenging, action is to stay the course. This is the ultimate secret recipe for successful investing, the only formula that builds fortunes in the markets!
Inflation (the one that the Fed looks at) is Heading in the Right Direction
Despite all the commotion, the Federal Reserve is not taking its cues from the Core CPI (+6.3 from last year) but instead from the PCE (Personal Consumption Expenditure Deflator, +4.6% from last year). These are two alternatives for measuring price levels. One of the main differences between them is the cost of shelter, which accounts for 33% of the CPI but only 18% of the PCE.
As the chart below shows, PCE inflation is moderating much faster than CPI.
GRAPH 1 – CORE CONSUMER PRICE INDEX (CPI, RED LINE) AND CORE PERSONAL CONSUMPTION EXPENDITURE (PCE, BLUE LINE) DEFLATOR YEAR OVER YEAR CHANGE.
CPI is up 6.3%, driven by the cost of shelter, whereas PCE is slowing at 4.6%. The Federal Reserve's favored inflation metric is the PCE.
Source: Bloomberg Professional Services
Forward-looking metrics indicate that rent increases will likely moderate in the next few quarters, making CPI converge toward the PCE.
Market Stats (not the news) Favor You
Lastly, according to the Bespoke Investment Group, daily stock market drops of 4%+ are rare. However, they have already occurred three times this year. The historical record shows that market returns in the six and 12 months following such events are very strong, with extremely high consistency.
GRAPH 1 – S&P500 INDEX PERFORMANCE AFTER A 4%+ DAILY DROP (1953-2022)
Above average forward returns in the six months after a 4%+ drop are very common.
Source: Bespoke Investment Group
In other words, even if the narrative and sentiment are bleak at present, the odds significantly favor the steadfast long-term investor.
The adage, "Be fearful when others are greedy, be greedy when others are fearful!" will prove correct once more for those with patience and discipline.