May 14, 2021
Inflation was the word of the week on Wall Street as the consumer price index jumped 4.2% year-over-year in April. That was the index’s fastest rise since 2008. The unexpected jump in inflation pushed the Dow Jones Industrial Average down a combined 1,155 points on Tuesday and Wednesday, after having set a record close just three trading sessions prior. The week’s drop nearly evaporated by Friday’s close, however, as investors chose to buy the dip once they embraced the notion that rising prices will be a short-term phenomenon. Investors also found comfort in April’s retail sales results, which came in flat. The reading persuaded investors that consumer demand is not running hotter than the economy can handle. Overall, it was a volatile trading week, which saw the Dow Jones Industrial Average decline -1.14%.
Rising Prices Rock Markets
The Consumer Price Index for April jolted investors on Wednesday, rising 4.2% from the year ago period. That handily surpassed estimates for a 3.6% rise. The jump in the headline inflation figure was driven by a surge in energy and car prices, up 25% and 21% yoy, respectively. Although the figures imply that we may be at the beginning of a period of rising prices, investors need to keep in mind the increase was more pronounced because it was being compared to last year’s index reading when the pandemic had sent prices tumbling. The rise in car prices is a function of supply disruptions, particularly a semiconductor shortage which is again due to Covid. Making matters worse, prices were also unexpectedly impacted by the Suez Canal blockage in March, which delayed deliveries. Considering the extent of baseline effects and temporary Covid-related supply challenges, it is unlikely the Federal Reserve will react to the CPI reading.
Retail Sales Fizzle
Consumer demand fizzled in April as retail sales remained unchanged for the month. April’s reading follows a 10.7% surge in March, which was upwardly revised from a previously reported 9.7% increase. Excluding autos, gasoline, building materials and food services, retail sales actually fell -1.5% in April. April’s results suggest consumers are being cautious with their savings and they don’t appear to be in too big of a rush to spend their stimulus checks. As of April, U.S. households have accumulated $2.3 trillion in savings throughout the pandemic, providing them with ample funds to spend as we head into the busy summer travel season and as the pandemic comes to an end.
The volatility this week shows that investors are trapped between the notion that the economy is roaring and that valuations are heavily levered to low interest rates. Anything that threatens rates, whether that be inflation or the Fed’s own policies, will continue to spark the type of concern we saw earlier this week. Some inflation expectations are already baked into the market, but with supply chains gradually ramping back up and demand expected to normalize over time, the belief is that any inflation will be temporary. This is the view shared by the Fed. It is, however, hard to reconcile some of the price increases seen in commodities, gasoline, building materials and cars with the notion that there is not rampant inflation, but at the same time other price categories have either declined (i.e. food at home, medical costs, shelter costs) or remained flat (education). In some cases, those goods or services that have risen sharply, have simply returned to their longer-term average. Yes, we are running at a 3-4% inflation rate, but relative to a low point last year. We’re also at the beginning of a demand surge where consumers have ample funds. Even if the spending surge proves to be a “goat through a python” event, you can bet that markets are going to be jittery – first because of the threat of inflation, then when the Fed normalizes rates, and finally once the economy actually cools to its long-term growth rate.
The Week Ahead
It will be a light week for U.S. economic news with housing starts and existing home sales being the highlights of the week. In overseas news, the Eurozone releases composite PMI figures.
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Happy Black-Eyed Susan Day
Today marks the 97th running of the Black-Eyed Susan Stakes at Pimlico Race Course in Baltimore, MD. The Black-Eyed Susan is the headlining race for three-year-old fillies, or young female horses, that occurs on the eve of the Preakness Stakes. It covers 9 furlongs — or 1 1/8 mile of track — and is named after the state flower of Maryland.
A furlong is a unit of measurement that’s equal to 220 yards. The measurement has historically been used to measure farmland, with one furlong being the length of a furrow, or a channel plowed between rows of crops in a 10-acre field. When horse racing become popular in England in the 16th century, furlongs were then applied to racecourses. The term is now mainly used only in relation to distances in horse racing.
This weekend’s Preakness Stakes is the middle jewel of the Triple Crown, a series of three races in May and June. The Preakness, the main event of race weekend, welcomes both male and female horses, while the Black-Eyed Susan race is for fillies only. In 2020, a filly named Swiss Skydiver made history by becoming the sixth filly to win the Preakness with a time of 1:53.28. It was the second fastest 1 3/16-mile Preakness on record behind Secretariat’s 1:53 in 1973. Other fillies to have joined the Preakness winner’s circle include Flocarline (1903), Whimsical (1906), Rhine Maiden (1915), Nellie Morse (1924), and Rachel Alexandra (2009).
Each leg of the Triple Crown has its own filly race day, starting with the Kentucky Oaks the day before the Kentucky Derby at Churchill Downs and wrapping up with the Acorn Stakes at Belmont Stakes in early June. Unofficially, this series is called the “Filly Triple Crown” by some, and occasionally the Filly Triple Tiara. Stakes races are reserved for premium horses, carry the most prestige, and have the biggest purses. Each stakes race has its own requirements, such as the age or gender of the horses, and owners must pay a fee to enter which becomes part of the prize money. All of the horses racing in Black-Eyed Susan and the Preakness Stakes must be three years old.
The three-year-old age limit means that any horse has only one opportunity to win in its lifetime. Racehorses reach physical maturity at age four or five, but most have retired from racing by then. At age three, they are generally old enough to race fast but young enough to add the element of uncertainty where the winner can’t easily be predicted.
A cloud of controversy hangs over the races this weekend. One of the favorites to win the Black-Eyed Susan is Beautiful Gift, which has been trained by Bob Baffert. Another Baffert-trained horse named Medina Spirit failed a post-race drug test after winning the Kentucky Derby two weeks ago. An investigation is pending, and Preakness officials announced earlier this week that they are allowing Medina Spirit, along with Baffert’s other horses, to race at Pimlico, subject to additional pre-race testing and rigorous monitoring. The results of the additional drug testing could take several weeks. In the meantime, the show must go on, and Iced Latte, The Grass is Blue, Adventuring, and Beautiful Gift are top favored horses to win today’s Black-Eyed Susan. Experts favor Medina Spirit with 9-5 odds of winning tomorrow’s Preakness Stakes, along with Concert Tour, another Baffert horse, and Midnight Bourbon.