FOVL - What To Do After Cool CPI Triggers Market Rally

Summary

• Top-line inflation fell, sending the major indices higher.
• S&P 500's rally hides weaknesses in sub-sectors, namely in food and automotive.
• Stay invested in companies with strong branding power.

After falling and then settling below the 4,000 level, the S&P 500 ( SPY ) roared back to life when the U.S. Bureau of Labor Statistics posted consumer price index for November 2022. In the last 12 months, prices increased by 7.1% before seasonal adjustment. More meaningfully for investors, core inflation rose by 6.0% over the last 12 months.

When the Federal Reserve announces its rate hike on Dec. 14, 2022, its statement will comment on core inflation.

How should investors react to the CPI results? Each sector deserves a unique perspective.

Inflation Peaked In June 2022

The stock market treated the inflationary spike peaking in June 2022 at 9.1%. In November 2022, CPI rose by 7.1% Y/Y . The food index increased by 0.5%. Shelter costs, which are the largest contributor to monthly items, increased by 0.6% from the preceding month. This outweighed the -3.5% in utility gas service and -2.0% in gasoline prices.

Ahead of the report, oil services stocks ( OIH ) fell by around 8.3% in the last month. Crude prices ( OIL ) dropped by 11.68%. As a side note, when WTI Crude prices fell to $75, mainstream media blamed China’s zero Covid for the lower global demand. However, when China abruptly reversed those policies to re-open the economy, the media had no explanations.

The lower oil prices might weigh on energy markets. It will lower costs on the supply side. To ease inflation further, consumers will require corporations to pass cost savings through lower prices.

This is unlikely.

Invest In Strong Brands

Corporations that have strong branding power and effective marketing want to expand profits. Companies like Coca-Cola ( KO ), PepsiCo ( PEP ), Procter & Gamble ( PG ), and Johnson & Johnson ( JNJ ) will not lower product prices. They already raised prices in anticipation of steady producer inflation.

Consumers will not lower their demand for brand-name products.

Coca-Cola stock trades at a premium. Despite a poor valuation and growth grade, the company consistently delivers on profits. KO stock earned an A+ grade on profitability:

In the table above, the stock has a strong momentum grade. KO stock is trading in an uptrend since October.

Pepsi has almost identical grades to that of Coca-Cola stock. PEP stock has better momentum but scores worse on valuation and growth.

In the diversified consumer discretionary sector, P&G is highly profitable. With inflation easing, the company’s profits will rise as operating costs fall.

In the table above, P&G’s EBIT margin and gross profit margin are significantly higher than the sector median.

Investors should expect profit to continue with Johnson & Johnson, too. JNJ stock earned an A+ on its profitability grade.

Used Car And Truck Prices Slump

Used car and truck prices fell by 2.9% in November. Investors did not need to rely on Steven Cress’s ‘sell’ rating on Carvana ( CVNA ). The online used car seller spent too much on acquisitions and accumulated debt. Now it must rework its debt as cash flow burn rates increase .

Investors might speculate that CarMax’s ( KMX ) used car sales will rebound as prices fall. However, the company posted total unit sales falling by 6.4% in Q2 . CarMax is slowing its car buying. Depreciation costs are on the rise. In addition, CEO Bill Nash said that it lowered its promotional offerings .

Used automobile prices will keep falling. Consumers have less disposable income. Food and shelter expenses come first, while big-ticket items come next, if at all.

Higher Food Prices

How many consumers may verify the 0.1% increase in all food prices? For example, the price of eggs doubled in the last two years . Walmart ( WMT ) understood its customer priorities. To sustain same-store traffic, it might lower grocery prices. This includes replacing higher-priced, slower-moving brands with private label s.

Needless to say, investors should avoid food companies that consumers may substitute. Customers will switch from high-priced Beyond Meat ( BYND ) products to cheaper protein sources .

Although they have good profitability scores, growth at Tyson Foods ( TSN ), Hormel Foods ( HRL ), and Conagra ( CAG ) will worsen as cost inflation hurts demand.

Your Takeaway

The market index’s rally masks weaknesses in the underlying sub-sectors. Investors who buy the SPY ETF are making a bullish market call. Risks remain high. The pace of the Federal Reserve’s interest rate increase in 2023 is unprecedented. Its negative impact on the economy and jobs is only starting to show up.

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