Why Stocks Are Surging Despite a ‘Worrisome’ Inflation Report

Stocks to buy

When it comes to making money in the stock market, it’s all about the details. After all, those are what tends to drive stocks. And the details surrounding today’s Producer Price Index (PPI) report indicate that you should be buying stocks right now. 

Right now, investors are concerned about “sticky” inflation. The big fear is that inflation will flatline around 3% for the next few months. And that would force the U.S. Federal Reserve to hike interest rates again, which could break an already-strained economy and plunge America into a recession. 

Now, those are very reasonable fears. But in order for those fears to come true, inflation must prove sticky at 3%. 

If it falls to 2%, then it’s ‘game over’ for the bear thesis. In that scenario, the Fed will likely cut interest rates later this year, which would reinvigorate a strained economy and thrust us into a period of powerful growth. 

So, it all comes down to inflation. If inflation rises over the next few months, stocks will crash. And if it drops, stocks will soar. 

The details strongly suggest the latter will happen. 

Understanding April’s Hotter-Than-Expected PPI

To be sure, today’s PPI report – widely considered the best read on producer price inflation trends – ran hotter than expected. Producer prices rose 0.5% month-over-month in April, versus a 0.3% gain expected by economists. Surely, that means inflation is running hotter than expected, right? 

Not quite – rather, it all comes down to the details. 

The only reason producer prices jumped more than expected in April is because they were simultaneously revised lower in March. Initially, producer price inflation was thought to have run at 0.2% in March. But today, it was revised to -0.1%. That means March’s producer price inflation was revised 30 basis points lower, which explains why April’s producer price inflation ran 30 basis points hotter than expected. 

Excluding that revision, producer price inflation would’ve run in-line with expectations. 

That’s why, this morning, Fed Board Chair Jerome Powell himself said that April’s PPI report was “mixed” and not hot. 

Revisions drove this beat. 

Looking Ahead to the Incoming Inflation Data

More importantly, we believe that tomorrow’s Consumer Price Index (CPI) report – widely considered the best read on far-reaching consumer price inflation trends – should show that consumer disinflation continued in April. 

That’s because there is a clear split emerging between producer and consumer price inflation. 

For the past several years, since consumers kept paying up, producers have been able to pass on higher costs through price hikes. But it’s been made clear over the past few weeks that that dynamic has changed. Broadly speaking, consumers have stopped paying up. And in response, producers are now absorbing higher input costs and not passing them on to customers. 

This is strongly illustrated by the various District Feds’ April business surveys. 

Each month, District Feds survey the businesses in their regions. Those surveys include questions about price trends. And in April’s round of surveys, a common theme emerged – input price pressures rose (depicted by the orange line in the chart below), while selling price pressures dropped (blue line). 

In other words, businesses are seeing higher input costs, but they are absorbing those costs and not passing them on to the consumer. 

And we think that will result in a soft CPI report tomorrow.

The Final Word on Inflation

Just look at how closely the aggregate selling price index (the blue line below) across a variety of District Fed surveys tracks overall consumer price inflation (the orange line below). 

As is visible in this graph, the blue line collapsed in April. Given their close relationship, the orange line should plummet, too – which means tomorrow could be the start of inflation resuming its decline to 2%. 

If consumer price inflation does resume its decline, then it’ll be off to the races for the stock market.

That’s especially true for rate-sensitive stocks – assets very sensitive to rate changes that benefit the most from rate cuts and lower inflation. 

As it happens, AI stocks fall into that category. And thanks to all the AI spending going on right now, AI stocks also happen to have some of the best earnings growth at the moment. 

In other words, now looks like a really good time to load up on AI stocks. 

But you can’t buy just any old AI stocks. It’s vital to buy the right stocks at the right moment to maximize reward and mitigate risk. 

Find out our favorite AI stocks to buy right now.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.

P.S. You can stay up to speed with Luke’s latest market analysis by reading our Daily Notes! Check out the latest issue on your Innovation Investor or Early Stage Investor subscriber site.

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