There’s a surprising connection between Social Security’s cost-of-living adjustment and the stock market.
Social Security recipients can breathe a little easier now. On Thursday, they learned how much their benefits will increase next year — 8.7%. That will be the largest cost-of-living adjustment (COLA) for the program in 41 years.
It’s possible that this news could allow investors to breathe a little easier as well. You might not think that Social Security’s annual COLAs have any bearing whatsoever on the stock market. But there is a connection. Could the monster Social Security increase even signal a bear-market bottom?
Taming the real monster?
Inflation is the real monster behind the latest huge Social Security increase. COLAs exist to help prevent the value of Social Security benefits from being eroded by rising prices.
We also need to put the recently announced COLA into context. Yes, it’s the biggest adjustment in 41 years. However, the increase also isn’t as great as many experts and onlookers were predicting only a few months ago.
Earlier this year, some experts forecast that the next COLA would be in the ballpark of 11%. There’s a simple reason why the actual increase wasn’t nearly that high: Inflation over the past three months was not as high as it was earlier in 2022.
Granted, inflation hasn’t declined by much. In June, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), the inflation metric used to calculate Social Security COLAs, was 292.542. The CPI-W slid ever so slightly in July to 292.219, followed by another drop in August to 291.629. The September figure of 291.854 reflected a small uptick.
The monster of inflation hasn’t been tamed yet. However, inflation (at least, as measured by the CPI-W) has come down from its peak a few months ago. That could have a major impact on the stock market.
Why reaching peak inflation is important
Ed Yardeni is an author, economist, and investment strategist who has worked with many top institutional investors. When he talks, people listen. In June, Yardeni told CNBC, “We’ve got to see a peak in inflation before the market will be substantially higher.”
Why is reaching peak inflation so important to the stock market? The ongoing market downturn is largely a result of the Federal Reserve’s strategy of raising interest rates, which it’s doing rapidly in its efforts to fight inflation. But once the Fed thinks that inflation is cooling off, it will likely stop cranking up interest rates.
However, don’t expect the central bank to begin cutting its benchmark interest rates anytime soon. Federal Reserve Bank of San Francisco President Mary Daly cautioned stated earlier this month that she doesn’t anticipate any rate cuts in 2023. However, a stabilization in interest rates could be all it takes to convince many investors to begin buying stocks again.
A couple of flies in the ointment
There’s a big problem, though, with the premise that the latest Social Security COLA could signal a bear-market bottom. Inflation might not have actually peaked.
The Consumer Price Index for All Urban Consumers (CPI-U) increased slightly on a month-to-month basis from July to August and rose another 0.4% in September. The Fed’s favorite inflation metric, the core Personal Consumption Expenditure (PCE) price index, also rose a little month-over-month in August.
The Fed will need to see a clear downward trend for inflation before it will be ready to change its fiscal tightening tactics. This bear market probably won’t hit bottom until then.
Morgan Stanley analysts recently warned that the stock market might not rebound even if inflation has peaked. Their concern is that companies’ profits could suffer as prices fall but labor costs remain high.
Still, it’s possible that inflation has truly peaked even in light of the increase in September. That could lead to the Fed pausing its interest rate hikes in the near future. Morgan Stanley’s worries about earnings might be overblown. If so, next year’s huge (yet lower-than-previously-predicted) Social Security increase could be a signal that investors can breathe a bit easier. Unfortunately, it would still be premature to call a bear-market bottom.
