The consumer price index (CPI) is the inflation gauge. Inflation is the rate at which prices rise and in turn erode your purchasing power. It was released by the US Bureau of Labor Statistics (BLS) on a monthly basis. It measures the average rate of change in the prices consumers pay for a package of products and services compared to a year ago. The core CPI report does not include food and energy, which is separate. The report includes pricing data by industry and location to derive an overall overall CPI figure. The report is released monthly for the previous month’s data (IE: August CPI data is reported in September). The CPI reached a 40 years high from 9.1% in June 2022, indicating the possible peak of inflation. Incidentally, the S&P 500 Index (NYSEARCA: SPY) hit a low of $362.17 in the same month. Chance? Maybe not.
What does CPI measure?
The CPI is generally a measure of the cost of living for an average person. It covers price trends for thousands of items through nearly 23,000 retail and service businesses and 43,000 rental properties in 75 metropolitan areas across the country. It collects approximately 90,000 awards in eight categories of housing, clothing, transportation, education and communications, recreation, medical care, food and beverage, and goods and services. There is an overall CPI and a core CPI.
The financial markets pay most attention to the core CPI, which excludes food (14% of the total CPI) and energy prices (7.5%), as their volatility skews results. The core CPI is used to measure core inflation, which also excludes food and energy prices. Core CPI is like adjusted earnings, as many critics argue that food and energy prices affect households the hardest. For example, the December 2021 core CPI was 7% excluding energy and food. However, energy and food hit the consumer’s wallet hard. Within the energy category, petrol prices rose by 50.8%. Within the food category, beef roasts increased by 22.1%. The information is all contained in the BLS general CPI data, also known as CPI-U. It just requires a little digging. The Federal Reserve also refers to the core CPI or core inflation in policy announcements and is widely regarded as the benchmark for measuring the inflation trend. It is also used as a cost of living indicator to adjust employee wages, Social Security and Medicare payments. It can be used to yield curve and recessions during periods of monetary tightening and expansion.
What the CPI means for the stock market
As illustrated in the chart, the CPI and SPY had a positive correlation until April 2021, when the CPI rose to 4.2% from 2.6% last month. The CPI line (blue) crossed the SPY (pink) line. From then on, the negative correlation or divergence began. Rising CPI resulted in falling SPY and vice versa. The CPI peaked at 9.1% and the SPY hit a low of $362.17 in June 2022. We can only say in retrospect whether the peak will persist. When the July CPI came in lower at 8.5%, the SPY started its rally from the bottom. The big question is whether the CPI will continue to fall, meaning the rate hikes will finally kick in and the SPY will continue to rise. The SPY would rise in anticipation of the Federal Reserve slowing the size and pace of rate hikes, which is bullish for markets. In short, the CPI rises, the interest rate rises and the SPY falls. If the CPI falls, the interest rate falls and the SPY rises. It will take at least two or more months of sustained CPI decline for markets to gain a foothold in the rise, as a one-month pullback has been a false indicator for the past two years.