As we anticipated this week’s Consumer Price Index (CPI) report, we discovered a thought-provoking article on MarketWatch by author Jeffry Bartash. He concluded his piece with a comparison between the CPI and the Federal Reserve’s preferred inflation metric, the Personal Consumption Expenditures (PCE) index.
Bartash noted that the PCE index places less emphasis on housing costs than the CPI. Housing is often the largest monthly expense for many households. This discrepancy begs the question: why don’t the creators of the PCE, at the Commerce Department, consider housing an essential factor in understanding inflation trends?
This might explain why the Fed favors the PCE index over the CPI. Another reason could be that the PCE index accounts for changes in consumer behavior influenced by rising prices. As highlighted by Bartash:
“A grocery shopper, for instance, might opt for ground beef instead of ribeye to save money. Similarly, a customer in a hardware store may choose a cheaper, imported tool over an expensive American-made one.”
While these consumer adjustments might conform to the PCE’s logic, they often fail to accurately represent real shopping behaviors.
At the Economic Prism, we buy ground beef when preparing meals like hamburgers or meatloaf or when we want a simple weeknight meal with Hamburger Helper. We indulge in ribeye when we crave a steak. If ribeye prices soar, we might settle for top sirloin, but we wouldn’t default to ground beef.
In the same vein, when selecting tools, we don’t prioritize whether they are made domestically or abroad. Our decisions are based on a balance of quality and price, aiming for products that will effectively complete the job.
Price Fixing
Clearly, the analysts at the Commerce Department are overlooking something crucial.
The gap between actual consumer behavior and the assumptions of government statisticians is enormous. Still, a plethora of data is collated each month and distilled into a single number.
The Federal Reserve’s central planners then manipulate the credit market using this number to adjust interest rates. In essence, they are fixing the price of money, which impacts all other prices—covering goods, services, commodities, and assets throughout the economy.
The Fed’s attempts to steer the economy through interest rate adjustments create an ongoing cycle of booms and busts. Moreover, these interest rate decisions often lead to a frenzied atmosphere on Wall Street.
The rationale is straightforward: a lower CPI or PCE reading signals that the Fed may lower interest rates in the near future, which would in turn make credit more accessible, potentially stimulating the economy and elevating stock prices. Speculators tend to act on these predictions, often reinforcing them in a self-fulfilling manner.
One popular theory among traders is that negative economic news translates to positive outcomes for the stock market. A disappointing GDP figure or a rise in unemployment may be interpreted as a precursor to Fed rate cuts, suggesting that stocks might rise as a result.
This entire narrative, rooted in manipulated statistics, is absurd. Yet, it possesses a tangible reality that defies logic.
Dip Buyers Return
The PCE index report for January will be available on February 29—a leap year. One can only hope it is more favorable than this week’s CPI report. This week’s report revealed that consumer prices rose by 0.3 percent in January, accumulating to a 3.1 percent increase over the past year.
Economists surveyed by the Wall Street Journal had anticipated a CPI increase of just 0.2 percent for January, with a year-over-year increase of 2.9 percent—hoping this would mark the first CPI reading below 3 percent in nearly three years. However, the government statisticians were unable to mask the reality of rising prices.
Notably, Core CPI—which excludes food and energy costs—showed a 0.4 percent increase in January and a 3.9 percent rise over the last year. Additionally, shelter costs surged by 0.6 percent monthly, culminating in a 6 percent increase compared to a year ago.
Initially, Wall Street reacted negatively to the report, causing dreams of interest rate cuts in March and May to dissolve.
Following Tuesday’s report, the DJIA fell by 1.35 percent, the S&P 500 dropped by 1.37 percent, and the NASDAQ declined by 1.8 percent.
Meanwhile, Treasury Secretary Janet Yellen remarked, during her address at the Detroit Economic Club, that the market’s reaction was a “tremendous mistake.”
By Wednesday, however, investors looking to capitalize on dips returned to the market, lifting major indexes back into positive territory. Shares of NVIDIA Corporation surged 17 points as the company approaches a $2 trillion market capitalization.
Wall Street Clustery
The late Sir John Templeton once noted that, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
It doesn’t take a visionary to see how a stock price chart of NVIDIA might play out. A glance at Cisco Systems’ performance circa 2000 serves as a cautionary tale; its shares are still priced below their all-time high nearly 24 years later.
Currently, an analysis of the three major U.S. stock market indexes suggests we are in another phase of unwarranted euphoria. Stocks are soaring, with little to hold them back.
For index fund investors, the current climate presents a paradoxical opportunity—to buy high in hopes of selling low later. This is precisely what many are doing.
John Hussman of Hussman Strategic Advisors has likened today’s bull market to previous ones, noting that his recent findings paint a starkly negative picture.
“Based on a variety of indicators including valuations, internal metrics, overextending scenarios, and numerous technical, fundamental, and cyclical gauges we’ve developed over time, we believe current market conditions now ‘cluster’ among the worst 0.1% instances in history. They bear strong resemblance to significant market peaks and stark dissimilarity to major market lows in over 99.9% of all post-war periods.”
“I refer to this as the ‘Cluster of Woe,’ since past instances with similar extremes—such as in 1972, 1987, 1998, 2000, 2018, 2020, and 2022—often preceded rapid market declines of 10%-30% within 6-10 weeks, with an average loss of 12.5%, and the smaller declines usually led to even steeper losses later on.”
Indeed, it is quite a cluster, and it’s all part of an ongoing cycle. Are you prepared for what may come next?
Sincerely,
MN Gordon
for Economic Prism
