NEW YORK, NEW YORK – NOVEMBER 15: Traders work on the floor of the New York Stock Exchange (NYSE) on … [+]
October 2023 inflation data sparked a positive reaction in financial markets. Stocks and bonds reacted favorably as stocks rose while bond yields fell, pushing prices higher.
Following the publication by the Bureau of Labor Statistics of October Consumer Price Index Report, the S&P 500 ended November 1 up 1.91% and the Nasdaq rose 2.37%. Small caps stood out with an impressive 5.44% rise, as represented by the Russell 2000 index. Most major asset classes found something to cheer about in the CPI.
The most encouraging news from the report is that inflation remained stable in October after rising 0.4% in September. October’s unchanged figures brought the year-on-year CPI rise to 3.2%, from 3.7% in September, and beat forecasts for year-on-year inflation of 0.10%. Even though inflation remains above the 2% target set by the Federal Reserve, it continues to follow a downward trajectory.
Investors should interpret the strong market reaction to the CPI which came in 0.10% below expectations as a warning to approach risky assets with caution. Although the CPI outperformed expectations, indicating a cooling in inflation, the reasons to question the market’s response become clear when diving into the details of the report. It is essential to consider the possibility of similar market reactions to future CPI numbers, but perhaps in the opposite direction.
Basic ex-shelter services
The Fed’s preferred inflation measure, Core Services Ex-Shelter, increased to 3.9% over one year, compared to 3.7%. The Fed places a heavy emphasis on this measure because it excludes lagging data on housing and energy services, providing a more accurate picture of inflationary pressures.
With demand for services remaining high and inflationary pressures appearing to persist, all indications are that the Fed is unlikely to adjust rates in the near term.
Health Insurance CPI
The health insurance component of the CPI has skewed the index downward over the past year. If we examine the Health Insurance CPI year-over-year data reveals a 34% decline. Health insurance premiums have increased significantly post-COVID, by some estimates, by more than 7% last year.
The method of calculating the CPI for health insurance price changes is complex. Delays in elective medical care during Covid-19, followed by a rush of postponed procedures, have caused substantial distortions in this much-overdue data set.
The BLS began implementing a correction in October 2023. Over the next few months, investors can expect stronger insurance inflation numbers as the moving average spreads lower CPI numbers by the calculation window.
Bureau of Labor Statistics Health Insurance CPI-U, year-over-year percentage change.
Essentially, due to the flawed methodology of calculating the CPI, the market’s dramatic reaction to a report barely beating expectations by 0.10% is irrelevant. This is well within the margin of error. Inflation is trending downward, but the rate of change is slowing, while the measure of inflation the Fed focuses on is a year-over-year increase.
The takeaway for investors is that the excitement surrounding the CPI release indicates significant risk in a market primed to react positively or negatively to even minor economic indicators and events. In such periods, the stock trend is up and, indeed, the trend is your friend. However, it is essential to be aware of the risk and adjust your positions accordingly, lest the next news or data deliver an unforgettable lesson in risk management.
