Inflation is Moderating

Stocks opened lower today but quickly recovered (Dow -55 points, S&P -.1%). Energy, healthcare and technology sectors—representing nearly half of the US stock market—are in the green. Most everything else is flat-to-down in early trading. Over the last month the VIX fear gauge has fallen from 35 to 25, suggesting less near-term volatility. The bond market, hammered over the last week, is attempting to rally this morning. The news media is making a big deal about the 10-year Treasury yield bumping up to 3%, as if that’s a key psychological level. This is nonsense. The 10-year ticked over 3% a month ago before a brief pause, and will likely do so again very shortly. Rates are headed higher.

Target (TGT) issued its second profit warning in three weeks, reducing expectations for the second quarter. Management now expects its operating profit margin to be 2% vs. the prior estimate of 5.3%. The announcement simply highlighted the magnified impact of a problem it has already identified—sharply lower demand for goods favored during the pandemic. Economists have been shocked by how quickly consumers shifted spending away from electronics, appliances and apparel, in favor of travel & entertainment. Retailers like Target, Wal-Mart and Amazon are left with excess inventory that will take six months to work off. All three companies say they’ll discount merchandise to move it out. The takeaway for investors, of course, is that high inflation can push consumers to change buying habits rather quickly. Demand is moderating and prices are poised to fall in response. To us, that sounds like deflation.

The same trend is now at work in the auto industry. Coinciding with a brief spike in new car sales (combined with low inventory) a year ago, dealers jacked up prices 10-25% over MSRP. We’re now seeing signs of collapsing demand. According to Ward’s Automotive Group, annual US demand for new cars hovered around 17 million, but over the last year has fallen to 12.7 million. And Manheim’s latest Used Vehicle Report shows prices have been falling for four straight months.

The World Bank says Russia’s economy will likely contract by nearly 9% this year as a result of global economic sanctions. (That’s considered a huge hit, but Ukraine’s economy will be cut in half.) Still, Russia’s current account balance—exports minus imports—remains positive as it continues to export large quantities of oil and natural gas. The country’s invasion of Ukraine is disrupting the flow of commodities (especially wheat) around the world and will result in slower economic growth just about everywhere. World Bank projects the crisis will reduce global growth by 1.2 percentage points to 2.9% this year.