Bigger Stock Market Crash To Come?


in Memos & Musings · 5 min read

S&P 500 re-tested June lows

The stock market retested the June lows since the August inflation data was released and a hawkish Fed which says that it will take forceful steps to bring inflation down to 2%.

Before we panic, let’s slowly break this down. So firstly, let’s ask ourselves. What is causing the sticky inflation? 

U.S. CPI Data August 2022

If we take a look at the CPI data, energy would definitely be one of the categories that is causing the high inflation, and on top of that, food, transportation and shelter (which is housing) also contributed to the high inflation.

The next question to ask is then, how have the prices of these categories changed over the past few months? If prices are coming down, then that would be a good sign for inflation and the stock market. 

1. Energy prices

Although the August CPI data for energy index has declined by 5%, the overall energy index still rose by 23.8% over the last 12 months. That’s still very high!

But the problem here is that CPI data is lagging data. Any change in prices of the inputs will only get reflected in the CPI data after some time. 

In our recent Zoom sharing session, we shared that if you want to get a better understanding of how the inflation rate might change in time to come, instead of focusing on the CPI data, you can consider looking at prices of the inputs which will directly impact the inflation rate. For example, the Crude Oil Futures price chart or the Natural Gas Futures price chart.

Crude Oil Futures Chart

Natural Gas Futures Chart

What we want to observe is that oil prices and natural gas prices continue to come down for inflation to fall. And at the moment, we are seeing that price decline which is something good for the current inflationary environment.

But of course, the oil prices and natural gas prices are currently still more on the elevated side, so what we hope to see is that the oil prices continue to come down even more for inflation to fall further. But at least, the energy situation is improving, and not all gloomy.   

2. Global supply chain pressure

The global supply chain issues surfaced since the outbreak of COVID, which were then escalated by the Russia-Ukraine conflict and the renewed lockdowns in China. The good news is that we are seeing progress in the global supply chain pressure.

If we take a look at the Global Supply Chain Pressure Index (GSCPI) which integrates transportation cost data and manufacturing indicators to provide a gauge of the global supply chain conditions, we can observe that over the past 4 months, there has been easing of the global supply chain pressure.

Global Supply Chain pressure Index as at August 2022

Freight costs have also come down over the past few months. Take a look at trucking spot rates, they have come down since the peak in Jan 2022 and container freight rates have also been declining from the peak over the past few months. All these would ultimately help to cool down the high inflation.

Truck spot rates

Container freight rates

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3. Housing market

The third factor which is driving the sticky inflation is the housing prices. Rising housing prices also translated to rising rental rates. But right now with the rate hikes, the 30-year mortgage rate has increased to 6% which can help to cool down the housing market.

If we take a look at some statistics, the existing home sales and new home sales in United States have been declining since January this year. So we are headed in the right direction but for us to see the impact on the housing prices, it has to take more time before the housing prices can cool down further.  

Stock market moves ahead of the economy

At the moment, what we can observe is that there are indeed improvements to the energy prices, supply chain pressure, freight costs and the housing market over the last few months. However, it has to take time before we reach the optimum level to pull down inflation further. Just like a person who is trying to be healthier by working out more, it doesn’t happen all of a sudden. But overtime you should get better readings say from the BMI, cholesterol levels etc. 

More importantly, the stock market is not the economy. The stock market usually moves ahead of the economy. That means before the economy recovers fully, the stock market usually recovers first.

If we compare the historical performance of S&P 500 vs the historical U.S inflation rate, this is what we can observe.

During the Great Inflation period from 1965 – 1982, whenever the inflation rate peaks, the stock market is usually near the bottom. So if the inflation rate really peaks at 9.1% in June this year, could we be near the stock market bottom?

No one can give a definite answer to that but this chart tells us that we don’t have to wait until the CPI data comes down to a low digit before we see the stock market recovering. 

If you are an investor with a longer term investment horizon, then the current market volatility may be a good opportunity to buy more shares of the good businesses or to invest into the S&P 500 for those who prefer the broad based index.

This is also part of our Moneyball investing methodology that we talk about at TJI to be buying great businesses at depressed prices due to them being temporarily out of favour. In the short term, some of these businesses’ earnings may be slightly impacted in 1 or 2 quarters but they are the ones with strong financials to eventually tide through the tumultuous economic environment, whether is it inflation or recession. 

If you want to learn more on how you can make better analysis of the stock markets, you may check out our upcoming workshops here.

About Hazelle

Chief trainer of The Moneyball Investors Playbook program and founder of The Joyful Investors, a financial education firm that seeks to help avid investors learn to invest better and make the journey a joyful one. I graduated with a first class honors in Bachelor of Accountancy from Nanyang Technological University (NTU) and started my auditing career in one of the Big Four. I believe that once we know how to build our wealth sustainably, we can then live our best lives ever.

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