Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why the S&P 500 Is Defying Higher CPI Numbers
Transcript
- Lucas: The S&P 500 closed today at seven thousand four hundred fifty. That's within striking distance of its all-time high. And it comes after a CPI print that showed prices still climbing. Luna: So the market is basically shrugging off higher inflation. That feels like a shift from last year, when every CPI number sent stocks tumbling. Lucas: It really is a shift. April's CPI came in at three hundred thirty-two point four, up from three hundred thirty point two nine the month before. Core CPI also ticked higher. But the ten-year breakeven inflation rate — that's the market's own inflation expectation — actually dropped to two point three six percent. Luna: So the market is saying, 'Yeah, prices are up now, but we don't think that lasts.' Meanwhile stocks are rallying. That seems contradictory. Lucas: It does on the surface. But I think the key is that investors are looking past the headline number and focusing on what's driving it. A lot of the recent CPI pressure comes from services and from things like car insurance and rent — categories that are sticky but not necessarily a sign of broad overheating. Luna: And the Fed hasn't panicked either. The effective federal funds rate is at three point six three percent, basically flat. They've signaled they're comfortable waiting. Lucas: Exactly. The Fed's preferred gauge, the PCE price index, is at one hundred thirty point nine — up but not accelerating dramatically. Core PCE is at one hundred twenty-nine point six. So the central bank isn't getting a signal that they need to hike further. That gives the market cover. Luna: But some sectors are clearly benefiting from inflation more than others. Which ones are driving the S&P 500 right now? Lucas: Technology and energy are the big ones. Tech companies have pricing power — they can pass on higher costs because demand for their products is inelastic. Think about cloud services or enterprise software. Meanwhile energy stocks are riding higher oil prices, which themselves are partly inflationary. So you've got a market where the inflation winners are also the largest weights in the index. Luna: That's a pretty neat feedback loop. Higher oil prices boost energy stocks, which boosts the S&P, even as those same oil prices feed into CPI. Lucas: Right. And the converse is that the companies getting squeezed by inflation — think consumer discretionary, small retailers, restaurants — have a smaller impact on the index. The S&P 500 is market-cap weighted, so a handful of mega-cap tech and energy names can carry the whole thing higher even if the broader economy is feeling pain. Luna: So the index is telling a story that's partly real and partly an artifact of how it's constructed. That feels like something investors need to keep in mind. Lucas: Absolutely. And it's why you see this disconnect between the S&P and the Russell 2000. The Russell is down one point eight percent over the past five days, while the S&P is only off two percent — but over a longer horizon, the Russell has lagged significantly. Luna: Small caps are more exposed to domestic inflation and higher borrowing costs. They can't pass on price increases as easily. Lucas: And they don't have the same global revenue diversification. A company like Apple or Microsoft sells to the whole world, so a little domestic inflation doesn't hurt them as much. But a regional bank or a local manufacturer? They feel it directly. Luna: Speaking of feeling it directly — we talk a lot on this show about how inflation hits people's wallets. And I think one reason listeners stick with us is that we don't sugarcoat it. We also don't run ads. Lucas: Yeah, that's a deliberate choice. We want the show to be a resource, not a vehicle for selling you stuff. If walking through the economy with us has made something click for you, and you'd like to support that, there's a link at buy me a coffee dot com slash fexingo. Luna: It's a simple way to keep us ad-free and independent. No pressure — just putting it out there. Lucas: Alright. So back to the market-inflation disconnect. One more angle I want to hit: the bond market. Real yields — that's the nominal yield minus expected inflation — have been rising. That typically signals that investors expect stronger growth, not just higher prices. Luna: And rising real yields are usually a headwind for stocks because they make bonds more attractive. But here we are, stocks near highs. Lucas: That's the puzzle. But I think the resolution is that earnings have been coming in strong enough to offset the higher discount rate. Companies are reporting margins that are holding up better than expected. So even with a higher risk-free rate, equities still look reasonable on a relative basis. Luna: So the narrative is that inflation is being 'good' inflation — driven by demand, not by supply shocks or wage spirals. Lucas: Exactly. The market is essentially betting that the Fed has threaded the needle. That they've slowed the economy enough to avoid a wage-price spiral, but not so much that earnings collapse. And so far, the data supports that. The jobs market is still adding over a hundred thousand a month — private payrolls grew by one hundred twenty-two thousand in May, stronger than expected. Luna: But we have the official May jobs report coming Friday. That could change the picture. Lucas: It could. If we see a hot number, that might reignite fears of the Fed having to hike again. But for now, the market is comfortable with the idea that inflation is 'transitory 2.0' — not in the way the Fed meant in 2021, but in the sense that it's manageable and not accelerating. Luna: Transitory 2.0. I like that. It captures the nuance: inflation isn't going away, but it's also not spiraling. Lucas: And that's probably the right framework for the next few months. CPI will likely stay in the three hundred thirty to three hundred thirty-five range for a while. The breakeven rate suggests the market expects it to drift lower over the next year. So the S&P can keep grinding higher as long as earnings hold up. Luna: Unless something breaks. And there's always something that can break. Lucas: That's the thing about markets. They're always pricing in a probability, not a certainty. But today, the probability they're pricing is that this inflation is something we can live with.