Lessons for Investors From Crazy Reaction to CPI Data

In many cases, I learn more from the market reaction to major economic data than I do from the numbers themselves. The data, by nature, is backwards looking and prone to fluctuations from period to period, which makes it dangerous to place too much emphasis on any single print. Whatever the numbers, though, they are open to interpretation, and how traders view a release will often tell you what their default position is going forward.

On that basis, the immediate reaction to the CPI data this morning was not a good sign. However, later developments indicate that we could be at, or close to, a turning point.

Prior to the 8:30 release, S&P 500 futures (ES) were sailing along, looking to claw back the losses from yesterday’s extremely volatile session. Then, as you can see from the above chart, once the numbers came out, they completely fell out of bed. Those numbers can’t be described as good, that’s for sure, but they weren’t as disastrous as the chart would have you believe. Core CPI rose 0.6%, significantly more that the forecast 0.4%, with the more inclusive headline number rising 0.3%, versus the 0.2% expected. That left the headline annual inflation rate at 8.3%.

None of that is good news, obviously, but it does represent a slight improvement over last month, so it could be argued that inflation had at least plateaued for now. Given the unreliability of individual numbers that I mentioned earlier, it would be foolish to read too much into that long-term, but an optimistic market looking for a bottom after recent losses would have keyed in on that, and after a bad reaction initially, that seems to be what is happening. At first traders in every market, not just stocks, focused entirely on the bad news.

Every risk asset fell. Even “inflation hedges” like gold and bitcoin dropped on the news, as did prices on Treasuries and crude oil. And the dollar rose, both as a “safe haven” response and because of the possibility of even higher interest rates than previously anticipated. That all points to a reaction that is more about a “risk off” mood than a response to the actual implications of a miss on the inflation numbers.

It is interesting, though, that once the market opened, that big drop had been all but erased.

Futures bounced back quickly, and most of the other moves reversed, too. Oil jumped, the dollar gave back its gains, and the 10-Year yield pulled back from its highs. The logical explanation for that is that the initial reaction was driven by the market’s attitude to risk, while the reversals were about a more considered reaction to the actual data.

If that is the case, there are some clear implications for equity investors.

As it stands, there is still an aversion to risk, but a growing recognition that if inflation really has topped out, even before the first rate hikes have really been felt, some stocks in profitable, stable companies may be oversold right now. It means that while risky stocks with high volatility are likely to remain under pressure, stocks in more established companies that have pricing power and the ability to withstand short-term turmoil are probably over the worst and may represent good long-term value around these levels.

Companies like Deere and Co. (DE), which can benefit from higher agricultural prices for some time but is 17% down from its high just three weeks ago, look like good places to be. There are a few big tech names that should be considered too. Companies like Apple (AAPL) and Microsoft (MSFT) will be fine, but they have been caught up in the tech selloff and are now trading at their lowest P/Es for some time.

Individual names aside, though, the main lesson from this morning’s reaction to the CPI data is not to react too quickly to headline numbers. If you did that this morning, you may have sold on higher-than-expected inflation and would probably be ruing that now with all the major indices recovering their losses. From a longer-term perspective, the fact that calmer heads prevailed, and that the market was prepared to acknowledge that even a slight improvement from last month’s CPI numbers was a good thing, hint at the possibility of the worst of the selling being over. That isn’t certain, of course, and there is no doubt significant volatility to come, but, ironically, things look better now after this morning’s CPI misses than they did before.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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