- Stocks are rising on March 1 despite more inflation data.
- The rally on March 1 isn't likely to last and should not be trusted.
- There should be plenty more inflationary data as March moves on.
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Stocks are rising on March 1, largely ignoring the latest round of data suggesting that prices and input costs continue to rise. The latest ISM report revealed that prices paid increased to 86, which was well above estimates for 80 and much higher than January's reading of 82.1. One would have to go back to the summer of 2008 to find a higher reading on the index, an indication that costs are rising very quickly.
Equities have largely shrugged off the inflationary data, despite 10-year rates rising back to 1.44% and the 30-year climbing to back to 2.22%. Despite the bearish data for bond yields, real yields or TIPS have seen their interest rates fall to around negative 72 bps, which is largely why equities have risen.
More Inflationary Data To Come
The prices paid index is highly correlated to both the producer and consumer prices index. That's likely to suggest a strong year-over-year gain in the CPI and PPI data when it comes later in March.
Not Bullish For Stocks
Today's latest round of data is not bullish for equities and would suggest that rates continue to push higher overall. More importantly, it indicates that real yields push higher as well over time and that today's move lower in real yields is likely just a giving back from last week's rapid rise.
The rise in real yields has massively underperformed the rise in 10-year Treasury rates. That has resulted in breakeven inflation rates moving sharply higher, which has helped send the wrong message overall to the equity market. But as real yields begin to play catch-up to the nominal 10-year rate, it's likely to push those breakeven inflation rates lower, resulting in equity prices following lower, causing massive volatility.
One should care about the breakeven inflation expectations because equity prices have largely been chasing this move higher in recent months. However, the rise in the expectations was due to the large move higher in the 10-year, and because TIPS largely refused to move up.
The last time we saw a big divergence between the two 10-year and 10-year TIPS was at the beginning of 2013. The TIPS yield rocketed higher in that year, sending breakeven inflation expectations lower and creating a great deal of stock market turbulence in the process.
Additionally, the equity market today is trading at a much higher valuation today than in the past. In fact, versus breakeven inflation expectations, the S&P 500 hasn't been this expensive using forward 12-month earnings estimates since the late 1990s. This means that distributions in the TIPS market are likely to cause even greater volatility in the equity market than in 2013.
More interesting is that despite the 10-year TIPS yield moving lower today, the TIP ETF (TIP) is trading down, and an indication that perhaps that investors in the ETF do not believe that TIP yields will continue to head lower but will resume their trend higher. The TIP ETF and the S&P 500 have been highly correlated to one another, as one would expect. We can see that the recent move lower in the TIP ETF is likely a leading indicator to where the S&P 500 index moves going forward.
It likely isn't to get any easier as the weeks go on for stocks either, with the ISM services index on Wednesday, along with the ADP job report and the BLS job report on Friday. That means that one really needs to be careful not to chase equity presently because the inflationary data is only likely to grow worse in the weeks and months ahead.
That will at the very least cause a great deal of volatility.
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This article was written by
I am Michael Kramer, the founder of Mott Capital Management and creator of Reading The Markets, an SA Marketplace service. I focus on long-only macro themes and trends, look for long-term thematic growth investments, and use options data to find unusual activity.
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