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I have often said that, in many cases, the mood of the market and its reaction to economic data is a more important indicator for investors than the numbers themselves. On that basis, the different market reactions to the two sets of inflation data that has hit the wire over the last couple of days tells you everything you need to know about the current mood of traders and investors. The bad news from CPI on Tuesday prompted one of the biggest one-day percentage drops in the major indices in years, while the relatively benign, maybe even quite bullish moderation in producer prices yesterday put the brakes on the rout somewhat, but hardly resulted in a rousing rally in stocks. Clearly, traders are focusing on the bad news and are inclined towards pessimism at the moment.

There is, however, more to it than just mood. The differing reactions to bad and good data are also because the market is coming to the realization that while commodity and other input prices were the root cause of this bout of inflation, they are not what is driving it now. In fact, if you look at a chart for a commodity ETF like the Invesco DB Commodity Index Tracking Fund (DBC) since the beginning of June, you can see that raw materials have been trading in a range roughly twenty percent below their highs for a couple of months now.

DBC chart

That is what is reflected in a lower producer price index, but the higher consumer price index tells us that despite that, the cost of living for end buyers — that’s you and me — is still increasing. There are two reasons for that.

The first is that there is always a time lag before retail prices reflect changes in consumer prices. That is for obvious reasons, but not ones that people often think about, and that they tend to forget when parsing PPI and CPI data for clues. Put simply, the main reason is because raw materials bought today take time to be turned into an end product, shipped to their retail destination, usually via wholesalers, priced and put on the shelves or in the show rooms. The washing machine you are looking at today is priced based on input costs from at least three months ago.

There are, however, other costs to be priced into that machine that are much more immediate in their impacts. If the staff at the store you are in, and at every stage of the washing machine’s journey through wholesale and distribution are demanding and getting higher wages, those costs will factor into the eventual retail price, as will an increase in rental costs for the showroom or warehouse space.

Those two things combined are what are driving CPI higher, even as PPI falls, and they tell us a bit about the future. PPI may be moderating, but CPI will remain elevated, and inflation may even climb a little higher, for many months to come. We may indeed have seen “peak inflation” as some were saying after yesterday’s numbers, but it is a peak from which we won’t be descending any time soon. That understanding is interesting from an intellectual perspective, but it also has practical applications for investors over the next few months, too.

It means that traditional inflation hedges like materials and energy stocks aren’t the place to be. The materials price boom is over, and so, therefore, is the materials stocks boom. Instead, right now, pricing power is king. A company like Apple (AAPL), for example, that has built consumer dependency on its ecosystem can benefit, or at least be hurt less than others, in this environment. Banks will reap benefit from rising interest rates that will at least offset the rises in labor costs, so they have some protection too. Another approach would be to concentrate on industries destined to grow and where stocks can be bought relatively cheaply on the dip, things like Tesla (TSLA) and Rivian (RIVN) in the EV business, for example, or some of the more solid names in the fintech space.

The differing reactions to the two sets of inflation data may seem confusing at first, but when you understand why they are heading in different directions, the messages sent and the implications for investors’ strategies are actually quite clear.

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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