PEP - December CPI Report Preview: Four Predictions On How Markets Might React

2024-01-09 07:30:00 ET

Summary

• Markets started 2024 with a pullback after a nine-week winning streak: how important is the upcoming consumer price index report this Thursday?
• Lower energy costs and higher food prices are expected to impact the CPI report, with potential reactions in the energy and packaged foods industries.
• The report may also show a price change in automotive and used vehicle prices, affecting companies like CarMax and Carvana, while tobacco prices have increased (watch Altria, BTI, and PM).

Last week, markets started 2024 by pulling back and breaking a nine-straight-week winning streak. Last week’s job report, which I previewed here , discussed what the Federal Reserve would do. The consumer price index report scheduled for release this Thursday is the second of two economic data releases that matter. The stock market wants no inflation at worst and deflation at best. The falling price of goods might give the Fed a strong reason to cut rates after its policy meeting later this month.

Chances are higher that the Fed would exude a dovish, rating-cutting tone. It need not change rates until the economy shows signs of weakening. Still, the central bank will seek evidence of price stability in the upcoming CPI report first.

What will the December 2023 CPI data look like? Four sectors may react the most following the inflation report later this week.

1) Lower Energy Costs

In December, West Texas Intermedia (“WTI”) crude prices fell sharply from October – November prices. The November CPI report already benefited from the downtrend, as the energy index fell by 2.3% over the month. This resulted in a 6.0% drop in the gasoline index. This will help Thursday’s inflation report considerably since energy has a 6.963% relative importance on CPI for all urban consumers (“CPI-U).

Above: WTI crude price chart.

2) Higher Food Prices

In November, the price of food, which has a 13.42% relative importance, increased by 3.1% for all items. Food prices increased most notably for cereals and bakery products (+3.4%), beverages (+2.9%), other food at home, and food away from home.

Stocks in the packaged foods industry might react strongly to the report. General Mills ( GIS ) lost 1.9% in the last month. Conagra Brands ( CAG ) fell by more while Hormel Foods ( HRL ) barely rose. Kellanova gained ~ 5% in that time. These firms may have weak pricing power, unable to pass the higher input costs to price-conscious consumers.

Among the stocks mentioned, Hormel has the highest risk with a quant rating of “Sell.”

Readers may explore further by opening this link to run the same comparison .

Conagra has the highest potential upside, based on its strong valuation and profitability grade. Yet a stock’s future price does not depend on grades alone. Investors expect an erosion in profitability for these companies.

Companies with strong brand recognition may increase prices without consumer backlash. PepsiCo ( PEP ), Coca-Cola ( KO ), Monster Beverage ( MNST ) – drink suppliers - and Mondelez ( MDLZ ) – a confectionary supplier - are such firms. All but Monster stock have a Buy Quant Rating or higher. Pepsi and Coke are the top consumer staples by sector and industry rank:

Open this link for the above comparison .

The CPI report is unlikely to move these stocks.

3) Automotive and Used Vehicle Price Decline

The inflation report will show the impact of higher auto loan costs on vehicle prices. The Manheim Used Vehicle Value Index for December already suggests prices will fall on weak demand. This index showed wholesale used vehicle prices fell by 7.0% year-over-year. Compact car prices fell by 11.7%. Even the normally resilient luxury auto sector saw prices fall by 6.9%. The popular SUV/CUV category experienced a 6.5% drop.

In November, used car and truck prices fell by 3.8% Y/Y.

Used vehicle firms like CarMax ( KMX ) with a short interest of 11.74% and Carvana ( CVNA ) at a 41.6% short interest may move lower in response to the price drop. Still, used vehicle demand typically rebounds after consumers get their tax refund in the coming months.

Above: CVNA stock rose, beating most small-cap ETF ( IWM ) holdings.

Although the inflation report is bearish for automotive firms, selling pressure in the underlying company is waning. For example, Ford ( F ) issued an F-150 recall , which would increase operating costs. Despite many reports of the Lightning not selling as Ford had hoped , the firm raised the price of the 2024 F-150 Lightning by $5,000. These developments would weaken the correlation between the inflation data on vehicles and the stock’s investment potential.

Above: Ford stock in the last year compared to the S&P 500 ( SP500 )

In November, new vehicle prices rose by 1.3% Y/Y. In December, prices may rise by less if consumers choose to spend on holiday gifts and vacations instead.

Another example of a company forecasting weakness includes Mobileye ( MBLY ). The leader of autonomous driving technologies in the automotive sector plunged on Jan. 4. It issued a weak preliminary report and a disappointing full-year outlook for 2024 . Short-sellers have a short interest of 18.88% on MBLY stock.

4) Higher Tobacco Costs

Though tobacco and smoking products accounted for only 0.508% of the CPU-U, its 7.7% price increase and unadjusted percent change Y/Y in November is a notable change. Altria ( MO ), whose shares pay a dividend yielding 9.15 is in a yearlong downtrend. The stock lost 7.63% in the last year. Philip Morris ( PM ) fell by 4.49%, though its dividend is less at 5.34%.

Readers seeking huge yields are buying British American Tobacco ( BTI ) stock. The yield is 9.9%, while shares lost 23.9%.

The rising tobacco cost is a positive development for companies. Among the three, BTI is the stock that income investors have rebound potential. The firm unexpectedly wrote down a significant $31.5 billion in non-cash adjustment impairment charges on Dec. 6. Fortunately, the non-cash expense does not have an impact on BTI’s cash flow. In addition, it will offset capital gains from BTI’s sale in its $19.4 billion holding in ITC Ltd.

BTI has a mixed dividend scorecard:

Your Takeaway

Markets in 2024 are less reactive to economic reports. They are firmly convinced that the Fed is on an aggressive rate-cut mission. This view is too optimistic. The central bank is more likely to take a neutral stance on its rate policy in response to the inflation report. It wants financial institutions, especially regional banks, to operate on a risk model that accounts for interest rates at current levels.

Markets will increasingly depend on The Fed renewing the Bank Term Funding Program ("BTFP") which will expire on March 11, 2024. However, markets would welcome a weak inflation report because it introduces an accommodative monetary policy of rate cuts even sooner.

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