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What I Care About This Week | 2022 July 11

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Photo by Pixabay on Pexels.com

by Franklin J. Parker, CFA

The Summary

The Details

Inflation continues to be a hot topic, and it is dividing analysts.

While headline inflation continues to tick higher—this month’s is expected at 8.8% while last month’s was 8.6%—core inflation (inflation minus volatile food and energy) has been falling. Some analysts say “so what?”, food and energy represent a significant portion of household spending, so to the extent that inflation affects consumers it is having its effect.

Other analysts point to falling core inflation as a signal that supply chain woes and other expenses are beginning to normalize and, once the war in Ukraine subsides (or is better absorbed), falling food and energy costs will pull down headline inflation, too.

In my view, inflation has three affects that investors should be concerned with. (1) The role inflation has in the Fed’s policy adjustments, (2) the role inflation has in absorbing spending that would otherwise drive economic growth, and (3) its negative affect on consumer sentiment (when people feel poorer, they tend to spend less).

The Fed appears to be committed to bringing down headline inflation, so interpreting those figures through that lens is important for investors, and it does appear that consumers have had to curtail other spending in order to absorb higher food and energy costs. They also appear to be taking on more debt to compensate (which cannot go on forever). And consumer sentiment is hitting pretty extreme lows.

All of that said, it does not appear that consumers have curtailed their spending in a significant way just yet. Although, retail sales (on Friday) along with retail earnings will give us better insight into all of that. Signals that the consumer is struggling would up my timeline for a recession considerably. Slack demand is the typical cause of recessions, and up to now demand has been robust. If that is changing, the economy will likely start to sputter.

Chart of the Week

Since we are on the topic, this week’s chart shows the relationship between inflation and personal incomes. As the chart demonstrates, other than a couple of blips, 2022 has been the first year in a decade that households have seen their real incomes fall due to inflation. Most of the past decade has seen personal incomes increase more than inflation. So, event though personal incomes have risen higher than average over the past year, inflation has risen even more.

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