RDFN - Why Markets Gained After April 2023 CPI Report

2023-05-10 13:00:11 ET

Summary

• BLS reported April 2023 CPI of 4.9%.
• Monthly and yearly price changes in shelter, used automotive, and gas discussed.
• Watch out for these ETFs.

The widely watched Consumer Price Index lifted the index only marginally. Stock markets anticipated the expected monthly rise of 0.4% . On a year-over-year basis, April’s CPI rose by 4.9%, below the 5.0%. This validates a “higher (rates) for longer (term)” Fed Funds Rate. It will continue to increase the attractiveness of money market funds over dividend income stocks.

Despite the post-report rally, will the CPI data pressure stock valuations in the weeks ahead?

Shelter, Used Automobile, and Gasoline Lifted Inflation

The index for shelter contributed the most to the monthly all items increase. Shelter prices increased by 0.4% M/M and by 8.1% Y/Y. Gasoline prices gained 3.0% M/M but fell by 12.2% Y/Y. Used vehicle prices rose by 4.4% M/M while falling 6.6% Y/Y. This data suggests that the noisy short-term prices will contradict the long-term trend. Although vacation travel will increase demand for gas, a slower economy should weaken prices.

The used vehicle market is a special case. Auto suppliers like Ford Motor Company ( F ) and General Motors Company ( GM ) must slash prices and remove the supply shortage premiums. At a lower price point, consumers will buy a new vehicle instead. Similarly, electric vehicle makers are cutting prices, led by Tesla, Inc. ( TSLA ). Investors should consider avoiding electric vehicle ("EV") and internal combustion engine ("ICE") companies that cut prices to increase demand.

Rivian Automotive, Inc. ( RIVN ) did not join the price battle in Feb. 2023, citing a robust backlog . RIVN stock gained as much as around 10% after posting Q1/2023 results . The Truck EV supplier ended the quarter with $11.78 billion in cash. It forecasts achieving positive gross profit in 2024. Chief Executive Officer R.J. Scaringe said that Rivian’s backlog still extends well into 2024 . Its early customers are the brand ambassadors. They create a powerful flywheel, advocating the vehicle to potential customers.

Shelter Costs Rise

The Fed’s interest rate tool needs to pressure the persistently rising shelter price. However, stocks in this sector may anticipate strong real estate activity. For example, Zillow Group ( Z ) is up nearly 50% in 2023. Redfin Corporation ( RDFN ) added 53% in only a week, despite losing 55 cents a share on a GAAP basis . Still, speculators short covering their 17.3% short interest may explain the rebound in RDFN stock.

Shelter inflation matters because it increases living costs. Real income will fall which will hurt consumer demand for non-essential goods and services. Below is the average price data of various goods .

Elevated interest rates should slow the pace of inflation this year.

Interest Rate Pause

In the Federal Reserve’s recent policy meeting, Fed Chair Powell said interest rates could still rise . The markets disagree. According to the CME FedWatch tool ,

With the Y/Y rates of headline and core inflation easing slightly, the odds of the Fed Reserve pausing on rate hikes are rising, according to trading activity. The probability of the federal funds rate target range staying at 5.00%-5.25% at the June meeting increased to 89.2% from 78.8% a day ago and 77.1% a week ago, according to the CME FedWatch tool.

See "CPI rises 0.4% in April, but eases Y/Y, supporting Fed pause scenario."

The pace of interest rate hikes in the last year caused Silicon Valley Bank, Signature Bank, and First Republic to fail. The Fed believed that those banks had unique problems. If bank customers are confident in the banking system, they will stop withdrawing their deposits from regional banks.

Investors should watch regional banks like PacWest Bancorp ( PACW ) and Western Alliance Bancorporation ( WAL ). They have a short float of 18.3% and 8.15%, respectively. Their Seeking Alpha quant rating is unfavorable.

Short-sellers are ignoring the deep valuation in those two regional banks. PACW and WAL stock score an “A” on value:

Additional Investment Ideas

Since Sep. 2022, S&P 500 (SP500) has attempted to break above 4,170. The CPI report does not show a large drop in the core items that matter: shelter, food, and energy (gasoline). Investors should be wary of exchange-traded funds that are weighted heavily in consumer goods.

Income investors should notice the downtrend in Schwab’s U.S. Dividend Equity ETF that began in Dec. 2022. The 3.75% dividend yield trails that of U.S. treasury, especially at the short-term maturity. Below are the yields for the 1-month ( US1M ), 3-month ( US3M ), and 6-month ( US6M ) T-bill.

Fortunately, PepsiCo, Inc. ( PEP ) is the SCHD ETF’s biggest holding at 4.66% of assets . The beverage firm posted strong revenue growth and raised its dividend in May. 2, 2023 .

Your Takeaway

Investors may want to consider reducing equity exposure. The high interest rate levels will work into slowing the economy in the coming months. Savers have plenty of investment options. They may renew treasury holdings at shorter maturities. Those who believe interest rates will fall sooner will want to renew certificate of deposit holdings at longer maturity dates.

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