We have been consistent to calling three primary overhangs for the stock market: China’s Covid lockdowns affecting supply chains, Russia’s invasion of Ukraine causing high energy prices, and the Federal Reserve’s fight to quell record inflation. As a student of science, I like to be data-dependent: only make conclusions/ interpretations based on data. Unfortunately, we don't have data for what presidents Xi Jinping and Vladimir Putin are thinking. But we can delve into the price pressures gripping the American economy, turning to actual data in an attempt to draw some investable conclusions.

To do this, we want to look beyond the monthly headline updates that we are all too familiar with at this point, the consumer price index (CPI) and personal consumption expenditures (PCE). Those are crucial readings for every investor to be mindful of. However, by the time they are released, they are outdated and they only give us a window into consumer spending. The producer price index (PPI), also backward looking, gives us a reading on wholesale prices. 

What we want to look at here are some of the trends we are seeing in the commodity market and use that as proxy for input costs at the earliest stages of the supply chain. After all, the price of coffee beans will dictate the price of your cup of coffee at Starbucks. The cost of corn will dictate the cost to feed animals at farms, and ultimately the price of a burger at Shake Shack. Of course, the price of oil will determine the cost to get everything from the factory to your front door.

Have raw material costs peaked?

Overall, the Refinitiv/CoreCommodity CRB index, which tracks a basket of 19 commodities, indicates that raw material costs have already peaked. Some of the bigger declines from recent highs can be seen by looking at futures trading in cotton, wheat and corn, silver and copper, as well as U.S. crude oil and natural gas.

While this certainly does not represent the entirety of the commodity universe, it does serve to show the magnitude of the rollover we have seen in prices in only a few weeks’ time. Given that these declines for the most part took place in June, the current month, they are not yet reflected in any released government economic data such as the CPI or the PCE.

While there is a lag between declining input cost dynamics and the prices consumers ultimately pay, this exercise does offer some insight into the back half of 2022, indicating that producers should start seeing some relief on the input cost side of things. 

How helpful will this be to the stock market?

Any data showing easing of inflation would be welcome news to the Federal Reserve, who is waging a war on inflation with tightening monetary policy that risks tipping the entire economy into a recession. Recession risks should go down if the Federal Reserve doesn't have to increase interest rates so much, which again, is dependent on the inflation front.

In addition to the Federal Reserve and their monetary policy, lower inflation means upside for corporate earning margins, a fundamental for stocks. If input costs come down quicker than expected and selling prices hold at current levels, profit margins stand to benefit and serve to support stock prices.

In the end, while we hesitate to make a call that inflation has peaked, we believe the price action we are seeing in commodities certainly suggests so. There can be some more downside in stocks before we see the true market bottom, but the decline of so many crucial commodity inputs points to a very favorable risk/reward.