Gasoline spike pushes inflation to highest since 2023

[00:00:00]Canada's CPI data jumped by just over 3% in May with high gasoline prices pushing Canada's inflation rate to its highest since 2023. Here to give his insights is David Onyett, Jefferies economist and portfolio manager at Guardian Capital LP. Good morning. Thanks for joining us in studio.

[00:00:15]>> Good morning. Pleasure to be here.

[00:00:17]>> So, the survey for for most was expected 2.8% year-over-year increase in CPI.

[00:00:22]It's more than that, obviously. What were you expecting? Were you expecting it to be a little less than what we saw?

[00:00:27]>> Uh no, more or less expecting it to be in line with this. Uh we're dealing a lot with gas prices and the seasonal adjustment factors can be complicated there, but we're seeing you know, extremely large movements in oil prices, which are then triggering over to refined products, especially gasoline.

[00:00:40]So, that impacts the consumers at the pump. Um and I think the key here is that you know, obviously for everybody in their day-to-day life, the quality of life is impacted by higher cost of living. And if we look at this report, it was driven by food and gas prices, which obviously are key components of everybody's budget. Uh but from a policy lens and from a market lens, what really matters is we're not seeing this broadening out of the price pressures. Like over time, when you have higher oil prices, especially uh because they factor into like all modes of production, so like it's a a key input that are not just for like making products, but also for the logistics of it. Uh the big concern of central banks is when you start seeing those oil prices broaden out across the economy. So, the upward pressure on prices, at which point then there's when the concern starts to rise.

[00:01:25]But if we go back 2 weeks ago, the Bank of Canada made a point of saying that they're not yet seeing sort of that broadening out of uh oil price pressures onto other areas. And the report this morning seems to echo that, right?

[00:01:37]>> Which is interesting. Like I I don't know what the timeline would be for like you say broadening out. It's also kind of like a trickle-down effect of seeing these higher prices, right? Like when when do you think we would see something like that?

[00:01:47]>> Well, most estimates tend to be, you know, the way things flow in the production process is like a 6-month time horizon.

[00:01:52]>> Okay.

[00:01:53]>> So, from the start of the war to maybe the end of the summer is in theory where we'd start to see the pressures, but as you noted there, oil prices have come off a lot, right? Since we had the agreement uh the the initial agreement uh with the US and Iran, oil prices are down roughly 15 to 20%, right? So, that's one of the things that makes a CPI report like this a little bit backward-looking because going forward, we're not dealing with $90 oil barring some sort of uh escalation and falling apart of uh of talks and escalation in terms of tensions, but right now we're moving forward with lower energy prices. So, going forward, there's going to be less of an upward impact from oil.

[00:02:28]>> So, you don't think we would see like the impact of what we've been seeing over the last couple of months. We're not going to feel that down the road if this conflict is to resolve itself right around now, right? Because you were talking about the Bank of Canada, like markets are pricing in a further rate hike. Um but does today's data kind of support that or not?

[00:02:43]>> Well, so going back to 2 weeks ago when the Bank of Canada made their announcement, um there's a lot more balancing act in Canada because we're concerned about growth or QN GDP uh missed expectations.

[00:02:54]We're in the midst of a technical recession, which is two consecutive quarters of negative GDP growth. Uh if we look year-to-date, overall employment is negative even though we had a very strong report uh for the past month. Uh and the concern is that if you start raising interest rates in an environment where growth momentum is slowing, you're going to exacerbate that problem, right?

[00:03:12]At which point then the inflation concerns are secondary.

[00:03:16]Um so, in this current environment, when you get sort of underlying prices, you're not seeing that broadening out yet, and you're getting that progress with respect to oil prices and the Middle East tensions. Um it allows the central bank to be a little bit more focused on the growth, right? So, even though markets are pricing in, I think this morning when I was looking about 40 basis points of hikes by year-end, you know, the commentary that's if things continue on the you know, this negative course with high oil prices, and we're just not really seeing that. The prospect we think is lower, and I think the market is getting ahead of itself on the willingness of the central bank to be aggressive in this current environment.

[00:03:49]>> Uh energy cost trade uncertainties still obviously driving headlines despite what we're seeing, right? For the meantime at least. Is this changing how businesses are choosing to allocate their CapEx this quarter, do you think? Is this changing how businesses are looking at their strategy moving forward?

[00:04:01]>> Well, it impacts more at the margin and I think the big thing we're talking about CapEx right now, uh this is the AI narrative and the AI trade, which is sort of a more of a secular than a cyclical story. And the energy price can have more impact on the cyclical spending, right? Because if you're not certain in terms of what's going to happen with growth, then you're going to start pulling back.

[00:04:20]>> Yeah.

[00:04:20]>> But when we're talking about the AI narrative, this is sort of a longer, medium to longer-term sort of initiative and companies are realizing that, hey, if we want to be able to implement this going forward, we need to sort of start building the infrastructure now. And that's really what we're seeing the big build-out on in terms of investment spending. It's just, you know, at the margin the more cyclical spending is being restrained.

[00:04:40]>> Right. Okay, and so when we're talking about AI-related infrastructure, AI spending right now, a lot of that's still driving the markets. How sustainable do you think that is?

[00:04:48]>> Uh well, realistically, when you have 100% growth, that's not sustainable over time. You're going to see that start to taper off. But at the same point, if we're talking relatively near term, uh you get these great surveys in the US on sort of the adoption of AI technologies.

[00:05:03]Like, so how many companies are implementing it? And we're still roughly about 20%, right? And even though we're probably not going to get to that full 100% implementation across companies, >> 20 20% of companies are implementing AI >> They are implementing AI currently, right? And the expectation is based on these surveys, it's going to be 25% within 6 months. Sorry, they there's that 5% there. And the likelihood is as we move forward in this and if we do start seeing sort of the productivity gains that result from these technologies, you're going to see a broader uptake, right? So, while the 100% year-over-year growth rates are not necessarily sustainable, the likelihood is going forward, you know, there is still a lot of scope and capacity for that investment to to continue with a fairly robust pace of growth.

[00:05:42]>> So, we've seen though just 10 stocks driving 90% of the gains on the S&P 500.

[00:05:47]Is that concentration a risk?

[00:05:49]>> Oh, for sure.

[00:05:50]>> Yeah.

[00:05:50]>> Uh and I think as we've seen markets more and more move towards sort of the passive investing, you have a lot of investors who don't realize how concentrated their portfolio are cuz you know, you're taught that if you buy the S&P 500 index, >> Yeah.

[00:06:03]>> uh then you're buying the broad market.

[00:06:05]But increasingly, it's a situation where roughly 40% of the of the cap weight of the S&P 500 is in the AI narrative, right? Um And it creates opportunities, I think, from active investors standpoint. When you start to see some churn, like you could have the headline index flatline or start to go down, but it's not necessarily indicative of weakness across the market. It's just that people investors are realizing, "Hey, I don't like this concentration risk. I want to start diversifying my portfolio more readily, right?" So, those really sort of Again, these are giant cash cows of companies. It's distinctly different than other areas where things were getting bid up. And you can argue whether or not the valuations have become detached from fundamentals, but these are inherently good, strong companies to begin with.

[00:06:47]Uh but it is a situation where you can have people start realizing, "Hey, I want to scale back my exposure to these companies and allocate somewhere else."

[00:06:55]And if you look at the markets from a valuation perspective, overall things look expensive.

[00:06:59]And you can argue that there's some froth in those really bid up names, but the rest of the market right now looks pretty reasonably valued, right? And that's an opportunity that creates itself.

[00:07:07]>> Is there other sectors that you like or that you think, you know, if people are looking like, "Hey, I should diversify a little bit more." Are there are there areas you would you >> Oh, for sure. Um and I do think that we are approaching, especially if we're looking at the US and that sort of guides broad markets, uh they are in a situation where they're poised for a cyclical upswing, right? We have these uncertainties that are restraining things at the margin, but as sort of the political uncertainty ebbs, and let's assume that, you know, these negotiations, which we're here the headlines over the weekend, they're making good progress. If we see that continuing and that stress removes itself, and then and inflationary pressures start to subside, and then interest rates aren't moving up as high because expectations are, you know, central banks aren't going to have to react to high inflation, which is driven by high energy prices.

[00:07:50]>> Right.

[00:07:50]>> Um, if you start removing those headwinds, then it sort of opens up and then like from a fundamental perspective, you know, the US and Canada and Europe even in Japan, um, the consumer's on good footing.

[00:08:02]Uh, businesses are looking to spend especially with this AI narrative there.

[00:08:05]Uh, governments are looking to loosen the purse strings and have these massive stimulus projects coming into place, which really sets up for the cyclical upswing. So, if you're having, uh, areas of the the economy that are geared towards sort of the capex swing, not necessarily strictly tech, but if you look sort of the industrials and the energy sector where they have to reinforce the power grid, you know, there's opportunities there for sure.

[00:08:25]>> Okay, so we've got to wrap it up now.

[00:08:26]We're out of time. Appreciate you coming in studio as always. Thank you. That was David Jeffries, economist and portfolio manager at Guardian Capital LP.