RTX - What The Fed Is Poised To Do After August 2023 CPI Report

2023-09-13 10:33:47 ET

Summary

• The Consumer Price Index increased by 0.6% month-over-month and 3.7% for the year, above consensus, indicating rising inflation.
• Market participants already sold small-cap stocks, cereal, telecom, and media stocks in anticipation of persistent inflation.
• Federal Reserve rate hike decisions for later this month and November are also discussed.

The Bureau of Labor Statistics posted the Consumer Price Index for all urban consumers increased by 0.6% month-over-month. Over the last 12 months, it increased by 3.7% before seasonal adjustment. This is above the 3.6% consensus.

At the time of writing, the S&P 500 ( SPY ) did not change by much. It already fell by 0.55% the previous day. For the month, the index is mostly flat, compared to the 3.57% decline in the small-cap index, the Russell 2000 (IWM). Market participants are selling the small-cap sector in anticipation that inflation will persist. In response, the Federal Reserve will likely raise rates after its November 2023 policy meeting by 25 bps.

Three Inflationary Red Flags

Before diving into the headline data, readers should take note of three highly inflationary data points. First, motor vehicle insurance prices in the last year increased by 19.1%. This could hurt automobile ownership and lease rates. Consumers will give up their vehicles to avoid the higher insurance costs. In the year-to-date period, Allstate ( ALL ), Travelers ( TRV ), and MetLife ( MET ) are all down by 10% or more.

After the decline, shares still trade with a weak valuation grade, offset by strong profitability. Analysts revised their earnings per share expectations to the downside.

The monthly increase in energy prices is a second red flag. The CPI report highlighted the 12-month decline of -3.6% in energy.

In August, however, energy prices rose by 5.6%. This increase does not include the impact of WTI crude prices rising from $79 to $89 this month. In next month’s CPI report, watch out for energy prices rising again. Higher WTI crude prices will make their way through widely used oil and oil products like plastic. It will limit the efficacy of the Fed’s punitive interest rate hikes in achieving price stability.

Investors who missed out on the energy rally in the last few months should wait for a pullback. According to Seeking Alpha's quant rating, Exxon Mobil ( XOM ), Chevron ( CVX ), and ConocoPhillips ( COP ) all have a “hold” rating.

Cereal Prices Rise over 12 Months

In the last year, cereals and bakery products rose by 6.0% over the 12 months ending in August. This came as no surprise to investors. Shares of Kraft Heinz ( KHC ), Hershey ( HSY ), General Mills ( GIS ), and Campbell Soup ( CPB ) are down by up to 24.23% YTD.

Value investors should think twice about adding any of those stocks. All but KHC have weak valuation grades. Still, they all have strong profitability.

August Inflation Up 3.7%

Over the last 12 months, U.S. CPI increased by 3.7%. Gasoline accounted for over half of inflation. As mentioned above, this will limit the Fed’s use of monetary policy to slow energy inflation. It has no influence on the OPEC+ decision to cut output. Russia’s invasion of Ukraine continues to distort energy prices. In the latter case, investors may only react by considering the defense and aerospace industry (considered as “war economy” stocks).

Consider shares of RTX ( RTX ), Lockheed Martin ( LMT ), General Dynamics ( GD ), and L3Harris ( LHX ). Even though governments are expected to increase their spending on military equipment over the next few years, the stock prices are down for those firms.

Index Increase

The report indicated that indexes that increased last month included rent, owners' equivalent rent, motor vehicle insurance (discussed already), medical care, and personal care.

The food index increased again by 0.2%. The index for meats, poultry, fish, and eggs gained 0.8%. Pork increased by 2.2%. And cereals and bakery products rose 0.5%.

Index Decrease

Lodging away from home, used cars and trucks, and recreation were among those that decreased over the month. As always, stocks do not always reflect economic realities. Carvana stock popped to over $50 when its CEO bought shares, as reported on August 28, 2023 . CVNA stock is up 997% YTD. Astute short- sellers know that the Carvana CEO received almost half of those “bought” shares for free . Bears have a 46.19% short interest against the stock.

The index for dairy and related products fell by 0.4% in August. The fruit and vegetables index declined 0.2% M/M.

In the last 12 months, the food at-home index rose 3.0%. Readers will have a sense that food prices are higher than that. Their basket of food consumed will differ from the survey. As a result, consumers will continue to cut back spending on things that they do not need. Be wary of investing in sectors that have high debt and lower revenue prospects. As mentioned in my previous articles, telecom firms like AT&T ( T ), Verizon ( VZ ), and BCE ( BCE ) may underperform. The high dividend yield offsets their weak total returns.

In the media sector, Warner Bros. Discovery ( WBD ) and Paramount ( PARA ) dipped heavily. Consumers, after cutting the cord (cable) a few years ago, may cut streaming services.

Investor Takeaway

Investors need to prepare for the increasing prospects of the stock market falling further as future CPI reports come in hotter than expected. Watch treasury yields very closely from the market data/bonds tab . Better still, add the US 12-month ( US12M ), 10-year ( US10Y ), and 30-year bond ( US30Y ) to your watch list. The higher yields rise, the more attractive they are as a safe haven income asset class.

At the September meeting, the Fed will reiterate its stance on sustaining rates at current levels. Its pause on rate hikes will give regional banks time to manage their risks. In November, it will likely raise rates again and keep them there through 2024.

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