02/20/2024 Market Strategy
Sometimes a Haircut Is Just a Haircut
The S&P 500 and the NASDAQ Composite each moved slightly lower last week for the first time in seven weeks and for a second time in 16 weeks
Key Takeaways
- With 396 or 79% of the firms in the S&P 500 index having reported, results have been generally stronger than expected. At this point four-fifths through the season, earnings are up 5% from a year earlier on 3.5% revenue growth. Prior to the season’s start, a bottom-up analysis put expected growth at 1.3% YoY.
- Last week’s CPI and PPI reports showed inflation running hotter than expected in January causing the S&P 500 and the Nasdaq to slip slightly from their highs.
- The S&P 500 is up 4.9% in 2024 through February 16, with eight sectors posting positive returns. In our view this shows a continuation of a broadening in the rally that began on October 27 of last year.
That the market slipped some from its high perch last week after a spectacular bull run from the end of last October should have come as little or no surprise after two gauges of inflation ran hotter in January than what had been expected in surveys that measured market participant opinions.
The headline CPI index rose 0.3% in January from the prior month (a 0.2% rise was expected). From a year earlier, the 12-month change in the CPI slid to 3.1%, down from December’s 3.4% reading.
However, the core index, which excludes food and energy prices, rose 0.4% in January from the prior month, higher than the 0.3% expected increase. This left the 12-month reading in core inflation at 3.9% in January—the same as in December.
The details of the report show that pressure on the core index was broadbased and included a rise in shelter costs, health care, and car insurance— all well known by folks who pay for these items.
In our experience the “stickiness” of inflation is usually something that the Federal Reserve watches with vigilance especially in a rate hike cycle designed to put untoward levels of inflation back into check. The stickiness of the inflation noted by the markets last week has been in our view a risk to the rallies in both the bond and stock markets since late October to the degree that they occurred in conjunction with market expectations of Fed rate cuts as early as March this year.
We’ve been of the view that the Fed remains sensitive and committed to continued progress in reducing the core inflation rate toward its 2% target. To that end the likelihood of two to three rate cuts as intimated by the Fed in its late January FOMC meeting just a few weeks ago seemed to us measured and realistic as to the degree of progress the Fed has had with inflation thus far and the likelihood of what remains to be achieved.
As we said in recent editions of this publication the markets’ earlier expectations for a March rate cut followed by up to five more rate cuts this year appeared much too optimistic. We’d suggest that the recent CPI and PPI numbers should not be taken for granted in our view even as they could become subject to revisions going forward.
Lumpiness in the progress that an economy and its markets make coming out of a crisis—especially a series of crises (think Great Financial Crisis, pandemic crisis, supply chain crises and elevated geopolitical risks all in a 16-year period)—should be expected.
While the January PPI and the CPI reports may well serve to pump the brakes some on the recent spate of day to day bullishness that’s pushed stocks higher day to day this year, we do not expect them to slam the breaks on the positive progress the markets have made from 2023 through the early part of this year.
If anything the hotter than expected data should serve to curb any unwarranted enthusiasm that may have slipped into the mix of the current run and help keep traders and investors from taking things too much for granted.
We’ll suggest sticking with the fundamentals focusing on economic data, the results and any guidance from the current S&P 500 Q4 earnings season with an ear to what the monetary policy officials at the Federal Reserve and its regional branches are saying in the day to day.
Our expectations are for the Fed to remain vigilant against inflation, “sticky” or otherwise, and focused on making further progress toward its 2% inflation target. In nearly two years (since March of 2022) the Fed has made remarkable progress from earlier being “behind the curve” in addressing inflation to where inflation stands today.
It remains a progress not perfection story for now with the good news being all the progress the Fed has made (and thus far without a recession), the bad news (at least for now) there’s still more work to be done with the end point of the Fed’s rate cycle further out on the timeline than quite a few folks had thought.
That said it looks to us that we’re moving closer to the end of the Fed’s hike cycle with the likelihood that it’s not so much interest rates “higher for longer” but rather interest rates “on pause (or skip) at current levels until the Fed feels comfortable to begin cutting.
Last week’s data likely carried some effects of seasonality, making the inflation stickiness look worse than it may look in the months ahead.
Patience, prudent diversification, knowing what one owns and how it performs in varied scenarios with an overlay of right-sized performance expectations— remains our preferred stance.
We’ll stay invested while keeping the party hats and the rose-colored glasses in the box for now.
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