Why Investors Shouldn't Be So Happy About 8.5% CPI Inflation; They're Ignoring 'The Elephant In The Room'

The SPDR S&P 500 ETF Trust (NYSE: SPY) is up 3.4% in the past week, and much of the positive momentum has come after the July consumer price index (CPI) reading was up just 8.5% year-over-year. Investors have cheered the fact that inflation may have finally peaked, but Bank of America analyst Savita Subramanian said Monday that the S&P 500 is still far from out of the woods at this point.

Subramanian pointed out that 8.5% inflation is still extraordinarily high, and rising prices coupled with a booming job market is likely squeezing corporate profits.

Related Link: S&P 500 Logs 4th Straight Weekly Gain Following Encouraging Inflation Data

Margins Pressured: The Bank of America Corporate Misery Indicator monitors the economic climate as it relates to corporate profitability. The Corporate Misery Indicator uses CPI as a proxy for corporate pricing power, wages as a proxy for costs and the coincident indicators as a proxy for demand. Subramanian said all three measures moved in the wrong direction in July, suggesting third-quarter profits are getting squeezed.

"Beneath the surface, real growth remains weak, and investors’ laser focus on the Fed combating inflation via short rates ignores the elephant in the room," Subramanian said.

Other Market Headwinds: Second-quarter S&P 500 earnings numbers were better than feared, but Subramanian said even those numbers are somewhat misleading. S&P 500 revenue was up 15% in the second quarter, but that number was heavily influenced by the 77% revenue growth in the energy sector. In fact, only 53% of S&P 500 companies had sales growth in the second quarter that outpaced inflation, Subramanian said.

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To make matters worse, Subramanian said investors seem to be completely ignoring the Federal Reserve's quantitative tightening program. Based on historical correlations between quantitative actions and the market, Subramanian said the current tightening program implies a 7% decline in the S&P 500.

Benzinga's Take: It's understandable why a drop in the CPI growth rate in July would trigger a knee-jerk relief rally in the stock market, but just because things are finally not getting worse doesn't mean the economic environment is favorable for earnings growth or stock market upside. In the second half of the year, investors can expect more quantitative tightening, higher interest rates, ongoing inflationary pressures, S&P 500 earnings growth deceleration and U.S. midterm election volatility, none of which seems particularly bullish for stock prices.