CPI is Through The Roof, Fed Must Address Inflation

CPI Consumer Price Index

Market momentum is Red. We moved back to cash as investors took yet another hit on the chin. The price discovery will accelerate as investors look for a bottom. Today’s CPI (Consumer Price Index) was as bad as it gets. When the White House said earlier this week that inflation would be high, they suggested it would come because of high airline fares and surging jet fuel costs…

This excuse made little sense since aviation is just 5% of the market. The CPI jumped 8.6% to its highest level since 1981. Inflation is not going away until the Federal Reserve brings it under control. That’s terrible news for the market. 

The Government Lacks a Plan

I spent seven years in school, largely studying monetary and fiscal policy. Whether it’s my studies around the Fed’s Open Market operations or accounting classes that center around depreciation and amortization, “policy” is a core driver of the economy and markets. 

One of the first things I learned during the first week of graduate school was inflation. Government has two ways it can stop inflation. It can reduce the money supply… or create MORE supply through business-friendly policies. 

The latter is essential. If we want more supply, we’d cut onerous environmental regulations, eliminate tariffs, suspend antiquated shipping laws, and cut business taxes to help spur investment and deployment of capital. But in this environment, there’s ZERO chance that this administration will do any of these things. 

On the former, the government could reduce spending – through austerity. It could raise taxes and keep that capital out of circulation to cool off spending. It could encourage consumers to save money instead of spending. But, again… that won’t happen. So none of these ideas will fly. 

So that leaves the last option for slowing down money: The Federal Reserve. The Fed can reduce the amount of money in the system by raising interest rates and/or selling bonds from its balance sheet back into the economy.

By selling bonds, the Fed drains liquidity from the economy. For the market – that’s bombs away. In 2018, when the Fed drained $600 billion from the markets in its first round of Quantitative Tightening, the S&P 500 fell 19.8% in December 2018. 

Looking to The Fed After CPI Report

The Fed has told Americans that it can’t be worried about the stock market’s performance right now. And Friday’s CPI report officially ended the temporary bear rally that I projected… up to June 10. 

Now, we head into a gruesome schedule. On Wednesday, the Federal Reserve will announce its plans to raise interest rates for June. We also have the Producer Price Index early next week and Quadruple Witching on Friday. 

While a 50-basis point hike is baked into the markets… more banks are projecting a possible 75-point hike. And markets are starting to bet that the Fed will increase rates in July by a full 1%. 

The Fed is the only backstop to reduce inflation in this economy. And while a recession is very likely – there’s only been one soft landing in 1994 – the markets will be better off in the long-term. 

I believe that the Fed should shock the markets, rip the Band-Aid off and force the economy and stock market to rebalance NOW. Not in six months and not in nine months. 

If they don’t tackle inflation immediately, stagflation will be a horrible consequence. I say, “Let’s get it over with.” This is one of the rare times that I publicly agree with Bill Ackman. 

Price Discovery Strikes Again

For several months, I’ve discussed the danger of owning stocks at ten times revenue. Remember, to justify that valuation, a company must pay its investors 100% of revenue annually for ten years. That is all of the revenue, not the profits. It’s impossible to justify this valuation in a sane world. 

Today, shares of DocuSign (DOCU) plunged more than 24% as investors panicked after a terrible earnings report and forward guidance. As I explained, DOCU was a stock trading at 10x revenue just a few days ago. And there is plenty of pain ahead for these companies. 

There are 33 companies I’m watching with market capitalizations north of $10 billion that trade north of 10x revenues. The list includes Tesla (TSLA), Microsoft (MSFT), NVIDIA (NVDA), and Zscaler (ZS). Here’s the heat map of how those stocks performed on Friday. 

Only one company out of the entire universe was up on the day. I don’t expect this to get better for this list of stocks. And that should do even more damage for the Nasdaq in the weeks and months ahead. Remember, cash is your friend right now. This next leg down is ready to begin.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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