Wednesday, May 11, 2022

U.S. Inflation Eased in April to 8.3% Annual Rate; Aswath Damodaran on inflation and the markets; Progyny short pitch; Value Investing Seminar Italy

By Whitney Tilson

1) The Bureau of Labor Statistics this morning released its April consumer price index report, which showed that inflation dropped for the first time in eight months: U.S. Inflation Eased in April to 8.3% Annual Rate. Excerpt:

U.S. consumer inflation eased in April to an 8.3% annual rate, taking a slight edge off the steepest run of price increases in four decades as energy prices moderated.

The Labor Department's consumer price index reading last month marked the first decline in eight months, down from an 8.5% annual rate in March. The CPI measures what consumers pay for goods and services.

The annual rate of inflation has risen sharply since early 2021, when the U.S. economy's rebound from the COVID-19 pandemic accelerated, leading to supply disruptions and other imbalances that have put upward pressure on prices...

High inflation is a downside of strong growth, fueled in part by low interest rates and government stimulus to counter the pandemic's impact. The Federal Reserve faces the tricky feat of tightening monetary policy enough to quell inflation and cool the economy, without throttling growth and causing a recession. Central bank officials on May 4 raised rates by a half-percentage point, the biggest increase since 2000.

The drop in the 12-month inflation rate is a possible sign that price increases are starting to ebb after hitting a 40-year high in March. However, the high rate of one-month core inflation suggests that price pressures remain, said Aneta Markowska, chief financial economist at Jefferies.

Some of the price surges fueling inflation are starting to ease. Gasoline prices fell slightly in April, after the late February Russian invasion of Ukraine sent them skyrocketing. Since then, though, U.S. gasoline prices again climbed, reaching a new high on Tuesday.

Improving supply chains have also taken the edge off rapid price gains for vehicles – used car and truck prices were up 35.3% in March from a year earlier – and other goods. However, new sources of inflationary pressure are replacing those.

"Now what we're starting to see is that pressure is no longer emanating from the supply side – it's emanating from the labor-market side. And that's less likely to go away on its own," said Ms. Markowska. "So the Fed will have to work that much harder to get us back to 2% inflation."

My take: this report gives me greater confidence in my forecast of inflation dropping to around 4% by year end.

For more of my views on inflation, don't forget to sign up for the event I'm hosting, "The Coming Inflation Shock of 2022," on Tuesday, May 17, at 8 p.m. Eastern time.

It's completely free to attend – just click here to reserve your spot.

2) One of my favorite writers and thinkers, NYU Professor Aswath Damodaran, just shared some of the smartest commentary I've come across on inflation and its impact on the economy and the markets. You can read his blog post here and watch his 28-minute video presenting it here. Excerpt:

Stock and bond markets are unsettled, because of the threat of inflation. We were [spoiled] by a decade of low and stable inflation, and there are many in this market who have never dealt with high and unpredictable inflation...

It is precisely because we have been spoiled by a decade of low and stable inflation that the inflation numbers in 2021 and 2022 came as such a surprise to economists, investors and even the Fed. Early on, the inflation surge was explained away by the reopening of the economy, after the COVID shutdown, and then by stressed supply chains, and expectations about future inflation stayed low.

However, as reported inflation has remained stubbornly high, and neither COVID nor supply chains provided sufficient rationale, market expectations of inflation have started to go up. I capture this shift using two measures of expected inflation, the first coming from the University of Michigan's surveys of consumer expectations of inflation for the future and the latter from the U.S. Treasury market, as the difference between the 10-year treasury bond and the 10-year inflation-protected treasury bond (TIPs) rates:

To figure out where the markets might go, Damodaran argues that you have to consider three factors:

To the question of whether to sell, hold on or buy in the face of weakness, the answer will depend on your macro assessments of the following:

  1. Steady State Interest Rate: As noted in the last section, the 10-year bond rate has doubled this year, an uncommonly large move for U.S. Treasuries, and there are three possibilities for the future. The first is that the bulk of the move in rates is behind us, and that treasury rates now reflect updated expectations of inflation. The second is that, like the 1970s, we will play catch up with inflation, and that rates will continue to move up, until expectations on inflation become more realistic. The third is that inflation is either transient, and will revert back to the lows we saw last decade, or that the economy will go into a recession and act as a natural break on inflation and interest rates. Note that in all three cases, it is not the Fed that is driving rates, but what is happening to inflation.
  2. Equity Risk Premium Path: The equity risk premium of 5.24%, estimated at the start of May 2022, is at the high end of historical equity risk premiums, but we have seen higher premiums, either in crises (end of 2008, first quarter of 2020) or when inflation has been high (the late 1970s). I think that what happens to equity risk premiums for the rest of the year will largely depend on inflation numbers, with high and volatile inflation continuing to push up the premium, and steadying and dropping inflation having the opposite effect.
  3. Earnings Estimates: The strength of the economy has been a big contributor to boosting actual and expected earnings on companies in the last two years, and these higher earnings have translated into more cash returned in dividends and buybacks. The earnings estimates for the S&P 500 companies from analysts, at the start of May 2022, reflect that strength and there seems to have been no adjustment downwards for a recession possibility. That may either reflect the fact that equity analysts are not among those who expect a recession (or expect only a very mild one, with little impact on earnings) or the possibility that there may be a lag in the process between the economy weakening and analysts adjusting expected earnings.

3) The three Columbia Business School students who won the Pershing Square Challenge investment competition (and $100,000!) on April 26 pitched a short of Progyny (PGNY). You can see their 27-slide presentation here.

The company manages a clinical network to provide fertility benefits for large, self-insured employers and takes a 20% fee cut. It has been growing rapidly, and analysts expect it to post revenue growth exceeding 40% annually through 2026, with expanding gross margins.

The students, on the other hand, argued persuasively that revenue growth would only be 18.4% compounded, with flat margins.

Round one went to the students, as the stock dropped after the company reported first-quarter earnings last week – it's down 16% since their pitch.

Here are three of their overview slides:

4) I'm delighted to let you know that my friend Ciccio Azzollini and I will once again be hosting – for the 18th time! – our Value Investing Seminar in Trani, Italy on July 7 and July 8 (attendees fly into the nearby Bari airport).

We limit it to 50 people, many of whom share their latest thinking on where the best opportunities lie and outline their current favorite investment idea(s). It's fun, educational, and a great addition to any European vacation! You can learn more and register here.

Here's a picture of Ciccio and me with the port of Trani in the background:

Best regards,


P.S. I welcome your feedback at [email protected].