December 1, 2023
October CPI report offers key risk management lessons for investors

Inflation data for October 2023 evoked a positive reaction in financial markets. Both stocks and bonds responded favorably as stocks climbed while bond yields fell, pushing prices higher.

The S&P 500 traded 1.91% higher and the Nasdaq gained 2.37% for the week ended Nov. 1, after the Bureau of Labor Statistics released the October Consumer Price Index report. As reflected by the Russell 2000 Index, small caps emerged with an impressive 5.44% rise. Most major asset classes found something to cheer about in the CPI.

The most encouraging news from the report was that inflation remained stable in October after rising 0.4% in September. October’s unchanged data reduced the year-on-year increase in CPI to 3.2% from 3.7% in September, and raised the year-on-year inflation forecast to just above 0.10%. Although inflation remains above the Federal Reserve’s 2% target, it is trending downwards.

Investors should interpret the market’s strong reaction to CPI falling below expectations at 0.10% as a warning to exercise caution towards risk assets. While the CPI outperformed expectations, indicating a slowdown in inflation, reasons to question the market’s reaction became clear when looking into the specifics of the report. It is important to consider the possibility of similar market reactions to future CPI prints, but possibly in the opposite direction.

Core Services Ex-Shelter

The Fed’s preferred inflation measure, core services ex-shelter, rose to 3.9% from 3.7% year-on-year. The Fed places heavy emphasis on this measure because it excludes lagging housing and energy services data, which paints a more accurate picture of inflation pressures.

With demand for services remaining high and inflationary pressures continuing to appear, there are signs that the Fed is unlikely to adjust rates in the near term.

health insurance cpi

The health insurance component of the CPI has been distorting the index downwards over the past year. If we examine the year-on-year data of the Health Insurance CPI, it shows a decline of 34%. Health insurance premiums have increased significantly post-Covid, by some estimates by more than 7% last year.

The CPI calculation method for health insurance price changes is complex and complicated. Delays in elective medical care during COVID-19, followed by the rush of postponed procedures, created substantial distortions in this heavily delayed dataset.

BLS began implementing the improvements in October 2023. Over the next few months, investors can expect more significant insurance inflation numbers as the moving average removes the lower CPI data from the calculation window.

In short, due to the imperfect methodology of calculating the CPI, the market’s dramatic reaction to a report beating expectations by only 0.10% is insignificant. This falls within the limits of error. Inflation is on a downward trend but the rate of change is slowing, while the Fed remains focused on year-over-year increases in its measure of inflation.

The key takeaway for investors is that the market’s excitement from the CPI print signals significant risk aversion in a market ready to react positively or negatively to even minor economic indicators and events. At such times, the trend in stocks is upward, and in fact, the trend is your friend. However, it is important to remain aware of the risks and adjust your positions appropriately, lest the next piece of news or data deliver an unforgettable risk management lesson.

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