During the latter half of 2021, we published several reports looking at inflation and the impact on markets, (see here, here, and here).

After the release of December inflation figures, we decided to update some of our findings as inflation continues to climb higher.

Exhibit 1: All Urban Sample: All Items – Annual Inflation Rate

As we noted in prior pieces, much of the increase in inflation has been driven by the strong increase in commodity prices as demand from reopening economies and well-documented supply chain bottlenecks impact prices.

This is well reflected in CPI data as shown below in Exhibit 2, which (from top to bottom) shows the YoY increase in the energy, gasoline, and commodities, less food and energy, components of CPI.

Exhibit 2: CPI Energy, Gasoline and Commodities, Less Food & Energy, YoY Change

While energy prices seem to be rolling over, other commodity costs continue to rise, reaching a current cycle peak of 10.7% in December.

This increase has also been reflected in revenue and earnings growth expectations for the energy and materials sectors in the S&P 500. As shown below in Exhibit 3, reproduced from our weekly S&P 500 Earnings Scorecard (which can be found here), those sectors have the highest expected EPS and revenue growth estimates for 2021Q4.

Exhibit 3: S&P 500 Sector YoY Earnings and Revenue Growth Estimates

Source: I/B/E/S data from Refinitiv

As we noted in a previous piece, the increase in housing costs has received far less attention despite shelter costs as measured by Owner Equivalent Rent (OER) and Rent of Primary Residence, accounting for ~31% of the total CPI weight.

While both the S&P CoreLogic Case-Shiller U.S. National Home Price Index and the National Association of Realtors (NAR) median home price figures have retreated from record levels, they remain elevated, up 19.1% and 15.8% YoY, respectively (See Exhibit 4).

Exhibit 4 Case-Shiller U.S. National Home Price Index and the National Association of Realtors Median Price YoY Change

The pattern seen in prior housing cycles shows HPI leading the OER and rent figures by several months and continuing to rise after the peak in HPI has passed (See Exhibits 5 and 6).

Exhibit 5: S&P/Case-Shiller National Home Price Index vs. CPI Owner Equivalent Rent and Rent of Primary Residence YoY Change

Exhibit 6: National Association of Realtors Median Price vs. CPI Owner Equivalent Rent and Rent of Primary Residence YoY Change

If OER and Rent expense in the CPI measures follow this pattern again, we could see this impact continue into 2022 as other “transitory” inflation pressures fade, which could keep inflation figures higher than expected.

Turning to sector performance around peaks, we note that for the current cycle the energy sector has been the best performer for the past year (+49.4% through 1/21/2022) followed by real estate (+28.6%) and then financials (+25.1%).

Exhibit 7: S&P500 Sector Performance Around Potential 2021 Inflation Peak

As we noted in a prior piece (here) the energy sector has historically been the best performing sector in the year leading up to a peak in inflation, while the financials sector has been the weakest, even with the strong performance over the past year. For the year after the peak, the performance essentially flips, with financials the best performing sector on average while real estate is the weakest, followed by energy.

Exhibit 8: Average S&P500 Sector Performance Around Prior Inflation Peaks

(Click on image to enlarge)