Disinflation – Fact or Fiction?
CME: S&P Technology Select Sector (
XAK1!
)
The U.S. consumer price index (CPI) rose 0.5% in January and +6.4% year over year, reported the Bureau of Labor Statistics (BLS) on Tuesday. Excluding food and energy, Core CPI increased 0.4% monthly and 5.6% yearly.
Economists surveyed by Dow Jones expected the headline CPI to grow 0.4% monthly and 6.2% yearly. Expectations for core CPI changes were 0.3% and 5.5%, respectively.
On Tuesday, US stocks fell at open in response to the hotter-than-expected CPI report. But major indexes recovered somewhat at the close of the day. The Dow Jones Industrial Average slipped 156 points, or -0.46%, after initially losing over 300 points. The S&P 500 was flat at 4,136 (-0.03%), and the Nasdaq 100 gained 68 points to 11,960.
US Treasury yields ticked higher. 2-year yield went up 94 ticks to 4.628%, while 10-year yield lifted 36 points to 3.755%. Bond investors widely expected the Federal Reserve to raise rates by 25 basis points to the 4.75%-5.00% range in March.
Mega Trend in US Inflation
While we usually focus on the percentage changes in inflation, CPI data are constructed as indexes, each using 1982-84 price data as a baseline at 100. January CPI reading of 299.170 is 0.8% above December of 296.797. It is up 6.4% from 281.148 in January 2022 (Data in this section is from Table 1 in the January CPI release).
Interpretation: Today, the average price of goods and services in the U.S. is about 3 times as high as the price level from nearly four decades ago. This translates into a compound annual growth rate (CAGR) of 2.93% for the past 38 years.
Insights: Long-run inflation rate is almost one percentage point higher than the Fed policy target. With less restrictive monetary policy on one hand, but more expansive fiscal policy on the other, the 2% goal appears to be far fetching. Barring a major recession, I expect the US inflation to stay above its 3% historical average in the foreseeable future.
In the past four decades, cost of many consumer goods tripled in price, including Food (+219%), Energy (+183) and Core CPI (+202%). But there are noticeable outliners:
• Tobacco and smoking products, +1289%
• Motor vehicle insurance, +559%
• Medical care services, +502%
• New vehicle, +77%
• Apparel, +28%
January CPI Readings
Before diving into the data, we should know that when BLS releases CPI data in February, it readjusts the weighting to account for the latest changes in the cost of living. For 2023, CPI weights are updated annually based on a single calendar year of consumer expenditure data. This reflects a change from prior practice of updating weights biennially.
The changes of weighting by product and service category in the January report:
CPI Category Old Weight New Weight Change
Housing 46.40% 44.40% +2.0%
Entertainment 5.70% 5.40% +0.3%
Food 14.50% 14.40% +0.1%
Clothing 2.50% 2.50% 0.0%
Other 2.60% 2.70% -0.1%
Medical 7.70% 8.10% -0.4%
Education 5.20% 5.80% -0.6%
Transport 15.30% 16.70% -1.4%
Rising shelter costs accounted for nearly half the monthly price increase. The component accounts for more than one-third of the index and rose 0.7% on the month and was up 7.9% from a year ago. Energy also was a significant contributor, up 2% month over month (M/M) and 8.7% annually, while food costs rose 0.5% M/M and 10.1% annually.
Food: Up 0.5% M/M in January from 0.1% in December. Annualized inflation is 10.1%.
Energy: Up 2.0% M/M in January from -3.1% in December. Annualized gain is 8.7%, of which, gasoline (+1.9%), diesel (+27.7%), electricity (+11.9%), and natural gas (+26.7%).
Shelter: Up 0.7% M/M in January from 0.8% in December. Up 7.9% Y/Y.
Transportation: Up 0.9% M/M in January from 0.6% in December. Up 14.6% Y/Y.
While the headline CPI ticks down from 6.5% to 6.4% on an annualized basis, January price increase of 0.5% is significantly higher than the December reading of +0.1%.
Overall inflation level is undoubtedly on the way down, but price increases from food, shelter and transportation are very sticky and don’t normally go down once moving up.
Is disinflation a fact or fiction? I think we are somewhere in between, in the Twilight Zone.
The US Stock Market Narratives
In the past three years, the stock market narratives have changed several times:
• After the initial pandemic hit in March 2020, US stocks staged a very impressive bull run. Growth drivers were US companies innovating with new products and services and catering for “work-from-home” employees and “play-at-home” consumers.
• 2022 started with a major geopolitical crisis, pushing stocks sharply down. Fed rate hikes from March 2022 dragged major stock indexes into bear market territory.
• Since inflation peaked in July and the Core CPI reading confirmed it in October 2022, US stock market began to rebound, centering on the notion of “Fed Pivot”.
More recently, investors are caught by conflicting economic data.
• Unemployment at 50-year low vs. Big Techs pushing rounds of massive lay-offs;
• Lower inflation rate vs. “Eggflation” and “Shrinkflation” that consumers experience;
• Whether the Fed is hawkish or dovish depends on the next dataset.
While investors try to make sense of all these, stock market moves sideways. The 30-day returns for Dow and the S&P are -0.83% and +3.20%, respectively.
Are we at the beginning of a new bull market? Or is it a bear relief, a temporary rebound from a bear market? To make an assessment, you need to know how many more rate hikes could be (pick a number between 1 and 4), and what the terminal rate would be (5.0%, 5.25%, 5.5%, 5.75%, or 6.0%)? I have no idea.
When uncertainty becomes the dominant narrative, it’s time to explore opportunities that promise more certainties.
AI - New Engine for Economic Growth
One visible exception is Nasdaq 100, which gained 8.9% in the past month. S&P Technology Select Sector Index (XAK) had an even higher return at 9.5%.
Most Big Tech companies were vastly overstaffed during the pandemic years. With stock prices cutting by two thirds or more, they are forced to live within their cash flow. Cutting off unprofitable divisions and laying off redundant staff help them survive in leaner years.
This is certainly very painful for the tech workers and their families. To investors, Big Tech may have transformed itself from lofty Growth Stock to reasonably priced Value Stock. For Nasdaq 100, its trailing 12-month price/earnings ratio was 34 one year ago. It is 23.63 as of February 10th, according to Birinyi Associates.
Technological breakthroughs have always powered the US economy to growth for the long run. Personal computers in the 1980s, Internet for the 1990s, smart phones and mobile internet in the 2000s, and electric vehicles in the 2010s, just to name a few.
In my opinion, Artificial Intelligence will be our economic growth engine in 2023. While AI is nothing new, the viral success of ChatGPT has sensationally changed the game. Its popularity among mainstream consumers helps form strong support for all publicly traded companies in the AI sector, not just for OpenAI and its parent Microsoft.
While writing this report, I asked ChatGPT one question: “Please show me the top-10 publicly traded stocks in the AI field.” Below is his/her/its answer:
1. Alphabet Inc. (GOOGL) - Google's parent company, which has been investing heavily in AI technology and applications.
2. NVIDIA Corporation (NVDA) - A leading company in graphics processing units (GPUs), which are commonly used in AI training and inferencing.
3. International Business Machines Corporation (IBM) - A company that has been developing AI technologies for several years and has a range of products and services, including the Watson AI platform.
4. Microsoft Corporation (MSFT) - Microsoft has invested heavily in AI technologies, and its Azure platform provides a range of AI tools and services.
5. Amazon.com, Inc. (AMZN) - Amazon's AI capabilities are used in a variety of products and services, including the Alexa voice assistant and its recommendation algorithms.
6. Baidu, Inc. (BIDU) - A Chinese company that has been investing heavily in AI technologies, including natural language processing and autonomous driving.
7. Alibaba Group Holding Limited (BABA) - A Chinese company that has also invested heavily in AI technologies and has been developing AI applications for e-commerce, logistics, and finance.
8. Intel Corporation (INTC) - A company that has been developing hardware specifically for AI, including custom processors and FPGA chips.
9. Twilio Inc. (TWLO) - A company that provides cloud-based communication services and has been investing in AI technologies to improve its services.
10. Advanced Micro Devices, Inc. (AMD) - A company that develops CPUs and GPUs for AI applications and has been investing heavily in machine learning and other AI technologies.
This is very impressive. ChatGPT not only gives me a list of the companies, but also highlights each company’s involvement in the AI field.
Since ChatGPT doesn’t have data beyond 2021, we come back to our trusty TradingView to pull out 1-year return charts. What a brutal year! Only Microsoft manages to gain 5.3%. The rest in the list had negative returns from -10% to 40%. Twilio is the loss leader, yielding -66.8% in the last 12 months.
This drives home the two major risks in new technology investing:
Firstly, at an early stage, you have no idea which technology will win out at the end. Is it direct current (DC) or alternative current (AC)? Airship or Aircraft? VHS or Betamax? Cable TV or satellite TV? And TDMA or GSM for cellular signal?
Secondly, you do not know which company will become a leader in a winner-take-all market. If you go back in time and invest in the new automobile industry in 1908, you have a 99% chance of losing money, unless you luckily picked Ford, General Motors, or Chrysler out of the 253 publicly traded automakers.
Likewise, if you invested in mobile phone companies in early 2000, you likely picked Motorola, Blackberry, Ericsson, or Nokia. However, when an outsider Apple launch a breakthrough product, iPhone 1 in 2007, it knocked out all leading cellphone markers and became the ultimate winner. Right now, I predict that most electric vehicle makers will go out of business in five years, except for Tesla, and maybe BYD.
The Case for S&P Technology Select Sector Index
Consistently picking winners in emerging technologies is extremely difficult. Even the smartest stock picker could not beat the market. Take Cathy Wood’s Ark Innovation ETF (ARKK) as an example, its cumulative returns comparing to the Nasdaq 100 were:
• 1-year: -42.8% vs. -12.4%;
• 5-year: -2.1% vs. +85.1%;
• Since Inception (8-year): +100.3% vs. +203.5%.
Diversification is a very powerful concept in investing, notably in times of uncertainty. Concentrating on stock picking, many active managers tend to cloud objective assessment with their own conviction and lose sight of potential market leaders amid emerging mega trends. Passive investment via index futures focusing on the high-tech sector allows us to express our conviction and capture emerging trends.
XAK is one of the 11 sector indexes in the S&P 500. Its top holdings are Apple (AAPL), Microsoft (MSFT), Nvidia (NVDA), Visa (V), Mastercard (MA), Broadcom (AVGO), Cisco (CSCO), and Adobe (ADBE).
My research shows that S&P Technology Select Sector (XAK) outperformed many Big Tech stocks and ETFs in both short-term and long-term. According to Fact Sheet published by S&P, as of January 31st, the annualized historical returns are -15.22% (1Y), 13.82% (3Y), 16.22% (5Y) and 18.48% (10Y). Total returns since inception are 6,425.9%.
You may invest in one of the technology sector ETFs, such as SPDR XLK, iShare IYW, and Vanguard VGT. But CME E-Mini S&P Technology Select Sector Index Futures (XAK) has distinguished features over ETFs.
Firstly, XAK has five quarterly contracts to choose from: March, June, September, December and March 2024. This allows us to evaluate strategies focusing on expected future value of the index, up to 1 year ahead.
Secondly, you could place either Long or Short position, allowing both bullish and bearish strategies to implement.
Thirdly, initial margin of placing 1 contract is approximately 35% of the notional value. This built-in leverage could enhance the returns if market moves in the right direction.
Finally, by holding a long position on the quarterly futures contract and rolling it each quarter, investors could replicate the strategy of holding the stocks or the ETFs.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com/gopro/
XAK1!
) The U.S. consumer price index (CPI) rose 0.5% in January and +6.4% year over year, reported the Bureau of Labor Statistics (BLS) on Tuesday. Excluding food and energy, Core CPI increased 0.4% monthly and 5.6% yearly.
Economists surveyed by Dow Jones expected the headline CPI to grow 0.4% monthly and 6.2% yearly. Expectations for core CPI changes were 0.3% and 5.5%, respectively.
On Tuesday, US stocks fell at open in response to the hotter-than-expected CPI report. But major indexes recovered somewhat at the close of the day. The Dow Jones Industrial Average slipped 156 points, or -0.46%, after initially losing over 300 points. The S&P 500 was flat at 4,136 (-0.03%), and the Nasdaq 100 gained 68 points to 11,960.
US Treasury yields ticked higher. 2-year yield went up 94 ticks to 4.628%, while 10-year yield lifted 36 points to 3.755%. Bond investors widely expected the Federal Reserve to raise rates by 25 basis points to the 4.75%-5.00% range in March.
Mega Trend in US Inflation
While we usually focus on the percentage changes in inflation, CPI data are constructed as indexes, each using 1982-84 price data as a baseline at 100. January CPI reading of 299.170 is 0.8% above December of 296.797. It is up 6.4% from 281.148 in January 2022 (Data in this section is from Table 1 in the January CPI release).
Interpretation: Today, the average price of goods and services in the U.S. is about 3 times as high as the price level from nearly four decades ago. This translates into a compound annual growth rate (CAGR) of 2.93% for the past 38 years.
Insights: Long-run inflation rate is almost one percentage point higher than the Fed policy target. With less restrictive monetary policy on one hand, but more expansive fiscal policy on the other, the 2% goal appears to be far fetching. Barring a major recession, I expect the US inflation to stay above its 3% historical average in the foreseeable future.
In the past four decades, cost of many consumer goods tripled in price, including Food (+219%), Energy (+183) and Core CPI (+202%). But there are noticeable outliners:
• Tobacco and smoking products, +1289%
• Motor vehicle insurance, +559%
• Medical care services, +502%
• New vehicle, +77%
• Apparel, +28%
January CPI Readings
Before diving into the data, we should know that when BLS releases CPI data in February, it readjusts the weighting to account for the latest changes in the cost of living. For 2023, CPI weights are updated annually based on a single calendar year of consumer expenditure data. This reflects a change from prior practice of updating weights biennially.
The changes of weighting by product and service category in the January report:
CPI Category Old Weight New Weight Change
Housing 46.40% 44.40% +2.0%
Entertainment 5.70% 5.40% +0.3%
Food 14.50% 14.40% +0.1%
Clothing 2.50% 2.50% 0.0%
Other 2.60% 2.70% -0.1%
Medical 7.70% 8.10% -0.4%
Education 5.20% 5.80% -0.6%
Transport 15.30% 16.70% -1.4%
Rising shelter costs accounted for nearly half the monthly price increase. The component accounts for more than one-third of the index and rose 0.7% on the month and was up 7.9% from a year ago. Energy also was a significant contributor, up 2% month over month (M/M) and 8.7% annually, while food costs rose 0.5% M/M and 10.1% annually.
Food: Up 0.5% M/M in January from 0.1% in December. Annualized inflation is 10.1%.
Energy: Up 2.0% M/M in January from -3.1% in December. Annualized gain is 8.7%, of which, gasoline (+1.9%), diesel (+27.7%), electricity (+11.9%), and natural gas (+26.7%).
Shelter: Up 0.7% M/M in January from 0.8% in December. Up 7.9% Y/Y.
Transportation: Up 0.9% M/M in January from 0.6% in December. Up 14.6% Y/Y.
While the headline CPI ticks down from 6.5% to 6.4% on an annualized basis, January price increase of 0.5% is significantly higher than the December reading of +0.1%.
Overall inflation level is undoubtedly on the way down, but price increases from food, shelter and transportation are very sticky and don’t normally go down once moving up.
Is disinflation a fact or fiction? I think we are somewhere in between, in the Twilight Zone.
The US Stock Market Narratives
In the past three years, the stock market narratives have changed several times:
• After the initial pandemic hit in March 2020, US stocks staged a very impressive bull run. Growth drivers were US companies innovating with new products and services and catering for “work-from-home” employees and “play-at-home” consumers.
• 2022 started with a major geopolitical crisis, pushing stocks sharply down. Fed rate hikes from March 2022 dragged major stock indexes into bear market territory.
• Since inflation peaked in July and the Core CPI reading confirmed it in October 2022, US stock market began to rebound, centering on the notion of “Fed Pivot”.
More recently, investors are caught by conflicting economic data.
• Unemployment at 50-year low vs. Big Techs pushing rounds of massive lay-offs;
• Lower inflation rate vs. “Eggflation” and “Shrinkflation” that consumers experience;
• Whether the Fed is hawkish or dovish depends on the next dataset.
While investors try to make sense of all these, stock market moves sideways. The 30-day returns for Dow and the S&P are -0.83% and +3.20%, respectively.
Are we at the beginning of a new bull market? Or is it a bear relief, a temporary rebound from a bear market? To make an assessment, you need to know how many more rate hikes could be (pick a number between 1 and 4), and what the terminal rate would be (5.0%, 5.25%, 5.5%, 5.75%, or 6.0%)? I have no idea.
When uncertainty becomes the dominant narrative, it’s time to explore opportunities that promise more certainties.
AI - New Engine for Economic Growth
One visible exception is Nasdaq 100, which gained 8.9% in the past month. S&P Technology Select Sector Index (XAK) had an even higher return at 9.5%.
Most Big Tech companies were vastly overstaffed during the pandemic years. With stock prices cutting by two thirds or more, they are forced to live within their cash flow. Cutting off unprofitable divisions and laying off redundant staff help them survive in leaner years.
This is certainly very painful for the tech workers and their families. To investors, Big Tech may have transformed itself from lofty Growth Stock to reasonably priced Value Stock. For Nasdaq 100, its trailing 12-month price/earnings ratio was 34 one year ago. It is 23.63 as of February 10th, according to Birinyi Associates.
Technological breakthroughs have always powered the US economy to growth for the long run. Personal computers in the 1980s, Internet for the 1990s, smart phones and mobile internet in the 2000s, and electric vehicles in the 2010s, just to name a few.
In my opinion, Artificial Intelligence will be our economic growth engine in 2023. While AI is nothing new, the viral success of ChatGPT has sensationally changed the game. Its popularity among mainstream consumers helps form strong support for all publicly traded companies in the AI sector, not just for OpenAI and its parent Microsoft.
While writing this report, I asked ChatGPT one question: “Please show me the top-10 publicly traded stocks in the AI field.” Below is his/her/its answer:
1. Alphabet Inc. (GOOGL) - Google's parent company, which has been investing heavily in AI technology and applications.
2. NVIDIA Corporation (NVDA) - A leading company in graphics processing units (GPUs), which are commonly used in AI training and inferencing.
3. International Business Machines Corporation (IBM) - A company that has been developing AI technologies for several years and has a range of products and services, including the Watson AI platform.
4. Microsoft Corporation (MSFT) - Microsoft has invested heavily in AI technologies, and its Azure platform provides a range of AI tools and services.
5. Amazon.com, Inc. (AMZN) - Amazon's AI capabilities are used in a variety of products and services, including the Alexa voice assistant and its recommendation algorithms.
6. Baidu, Inc. (BIDU) - A Chinese company that has been investing heavily in AI technologies, including natural language processing and autonomous driving.
7. Alibaba Group Holding Limited (BABA) - A Chinese company that has also invested heavily in AI technologies and has been developing AI applications for e-commerce, logistics, and finance.
8. Intel Corporation (INTC) - A company that has been developing hardware specifically for AI, including custom processors and FPGA chips.
9. Twilio Inc. (TWLO) - A company that provides cloud-based communication services and has been investing in AI technologies to improve its services.
10. Advanced Micro Devices, Inc. (AMD) - A company that develops CPUs and GPUs for AI applications and has been investing heavily in machine learning and other AI technologies.
This is very impressive. ChatGPT not only gives me a list of the companies, but also highlights each company’s involvement in the AI field.
Since ChatGPT doesn’t have data beyond 2021, we come back to our trusty TradingView to pull out 1-year return charts. What a brutal year! Only Microsoft manages to gain 5.3%. The rest in the list had negative returns from -10% to 40%. Twilio is the loss leader, yielding -66.8% in the last 12 months.
This drives home the two major risks in new technology investing:
Firstly, at an early stage, you have no idea which technology will win out at the end. Is it direct current (DC) or alternative current (AC)? Airship or Aircraft? VHS or Betamax? Cable TV or satellite TV? And TDMA or GSM for cellular signal?
Secondly, you do not know which company will become a leader in a winner-take-all market. If you go back in time and invest in the new automobile industry in 1908, you have a 99% chance of losing money, unless you luckily picked Ford, General Motors, or Chrysler out of the 253 publicly traded automakers.
Likewise, if you invested in mobile phone companies in early 2000, you likely picked Motorola, Blackberry, Ericsson, or Nokia. However, when an outsider Apple launch a breakthrough product, iPhone 1 in 2007, it knocked out all leading cellphone markers and became the ultimate winner. Right now, I predict that most electric vehicle makers will go out of business in five years, except for Tesla, and maybe BYD.
The Case for S&P Technology Select Sector Index
Consistently picking winners in emerging technologies is extremely difficult. Even the smartest stock picker could not beat the market. Take Cathy Wood’s Ark Innovation ETF (ARKK) as an example, its cumulative returns comparing to the Nasdaq 100 were:
• 1-year: -42.8% vs. -12.4%;
• 5-year: -2.1% vs. +85.1%;
• Since Inception (8-year): +100.3% vs. +203.5%.
Diversification is a very powerful concept in investing, notably in times of uncertainty. Concentrating on stock picking, many active managers tend to cloud objective assessment with their own conviction and lose sight of potential market leaders amid emerging mega trends. Passive investment via index futures focusing on the high-tech sector allows us to express our conviction and capture emerging trends.
XAK is one of the 11 sector indexes in the S&P 500. Its top holdings are Apple (AAPL), Microsoft (MSFT), Nvidia (NVDA), Visa (V), Mastercard (MA), Broadcom (AVGO), Cisco (CSCO), and Adobe (ADBE).
My research shows that S&P Technology Select Sector (XAK) outperformed many Big Tech stocks and ETFs in both short-term and long-term. According to Fact Sheet published by S&P, as of January 31st, the annualized historical returns are -15.22% (1Y), 13.82% (3Y), 16.22% (5Y) and 18.48% (10Y). Total returns since inception are 6,425.9%.
You may invest in one of the technology sector ETFs, such as SPDR XLK, iShare IYW, and Vanguard VGT. But CME E-Mini S&P Technology Select Sector Index Futures (XAK) has distinguished features over ETFs.
Firstly, XAK has five quarterly contracts to choose from: March, June, September, December and March 2024. This allows us to evaluate strategies focusing on expected future value of the index, up to 1 year ahead.
Secondly, you could place either Long or Short position, allowing both bullish and bearish strategies to implement.
Thirdly, initial margin of placing 1 contract is approximately 35% of the notional value. This built-in leverage could enhance the returns if market moves in the right direction.
Finally, by holding a long position on the quarterly futures contract and rolling it each quarter, investors could replicate the strategy of holding the stocks or the ETFs.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com/gopro/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
