Used cars. Remember when they were a nice, affordable way to get you from point A to point B?
That is no longer the case…
Between January 2021 and the start of 2022, the cost of a used car jumped an average of 40%!
Now before you dismiss this little tidbit as a typo or the ravings of a madman, let me say I’ve confirmed it from a few different sources.
This surge in used car prices is interesting as a standalone data point. Use it to amaze your friends and family at the Thanksgiving dinner table. But as a significant input in the arcane formula that the Bureau of Labor Statistics uses to calculate the headline inflation rate, that’s more than just interesting…
A person could gain valuable insight into the Federal Reserve’s rate hike campaign and even generate market timing signals for trading and investment purposes by tracking used car prices.
Case in point: December 2021. Used car prices jumped 3.5% that month. And the month-over-month inflation rate was 0.5%. (Remember: the inflation rate is always annualized. So when the raw number is 0.5%, the media headlines will say that inflation is running at 6%.)
So, that 0.5% month-over-month jump in the inflation rate was the turning point for the stock market and the Fed. The Dow Industrials peaked at 36,189 in the second week of December 2021. The Dow managed to extend slightly to 36,952 in early January 2022, But the die was cast: the Fed would have to start raising interest rates because inflation was accelerating out of control.
And used car prices made up 0.11 of that 0.5% inflation number. A little over 20%.
Understanding Transitory
Fed Chair Jerome Powell had been famously calling inflation “transitory” for a solid year before it hit December 2021’s point of no return.
And I have made no bones about what a colossal mistake Powell’s lackadaisical attitude toward inflation was. Continuing to call inflation transitory even after it surged above the Fed’s 2% target in March 2021 was a cut-and-dry case of dereliction of duty. Had he been in the army, Powell would’ve been breaking rocks in the hot sun at Leavenworth.
I hate to admit this, but the fact is, I do have a little sympathy for Jerome Powell. Because…used car prices? I can see why someone in such an ego-confirming position as Chairman of the Federal Reserve might look at an inflation number that’s 20% driven by used car prices and think, “well, that’s stupid.”
Trailing Stops and Emotional Thinking
Of course, I’ve written before about how we, as investors, use hard and fast signals like trailing stops to automate our decision-making as much as possible. Emotions and “thinking” are always the enemy. Because it’s all too easy to come up with some reasonable explanation of why a stock we own is down 10%, and then it’s easy to think we should double down on that stock when it’s down 20%, and so on…
Simply selling a stock at a predetermined threshold is always the best way.
The emotional component of the human brain is exactly why the Fed has a 2% mandate on inflation. For the Fed, the 2% inflation level isn’t supposed to be a line in the sand that can be wiped away and redrawn. 2% is supposed to be the alarm that spurs the Fed to move. Don’t think, act.
The Latest on Inflation
So last Thursday, the Consumer Price Index (CPI) came in at 7.7%. That was just a tick lower than expectations, which ranged between 7.8% and 8%. Predictably, stock prices launched higher. The Dow Industrials added 1,200 points, a massive 5% one-day gain…
Because if inflation is starting to come down, the Fed may ease off on future interest rate hikes. Maybe even stop altogether. Maybe the bear market is over. Maybe we don't have to see unemployment spike to 5%. Maybe the U.S. economy won’t fall into recession…
All of these are good things, for sure.
But can you guess why last week’s CPI came in slightly lower than expected? Yep, used car prices. The price for previously owned vehicles was down 2.2% in October.
Eggs didn’t get cheaper. A sack of Tostito’s Hint of Lime is still over $5. Filling up your tank is still a pain in the…wallet. All that happened was instead of paying two grand, you could buy somebody else’s beater for $1,966! Sweet!
Now I’ve been telling you for the last 6 weeks that there was an Open Window of Opportunity and that the market was Climbing the Wall of Worry – all because sentiment has been leaning toward the Fed slowing down or stopping the rate hikes (the financial media likes to call this the “Fed’s pivot,” but I’ve come to hate the word “pivot” so I won’t use it except for the sake of clarity).
A better inflation number is what it is: a better inflation number. There’s no point in anticipating a stock reversal based solely on my exhilarating insight about how the inflation number is calculated. Likely, mo’ better inflation numbers (like the Producer Price Index, or PPI, which comes out tomorrow) will lead to mo’ higher stock prices.
But – it is time to be on the lookout for a reversal. Don’t chase any strong rallies. The Fed cannot back down just because the price of a used car fell a little bit. I expect investors might be a little disappointed when they figure this out.
And you know what happens when investors get disappointed…
Until next time,
Brit Ryle
The Profit Sector
