Above the Noise: Cooling concerns about a “hot” inflation report

I’ve been reading magazines lately and jotting down interesting excerpts. These quotes include “…interest rates have shot up higher than anyone could have imagined…,” “looming recession, government paralysis, and the threat of war,” “voters are indeed angry,” and “Americans are…worried about their financial future.” Some of you may be nodding your heads. Would it shock you to know that those selections are from 1982, 1990, 1991, and 2002, respectively?¹

Those quotes did appear during challenging times for the US economy, but also during or on the eve of monetary policy easing. It’s perhaps no surprise then that they also marked the beginning of prolonged market advances, albeit with inevitable volatility along the way.²

The more things change, well, you know the rest.

It may be confirmation bias, but …

… the stock market tends to do well when the Federal Reserve (Fed) cuts interest rates and the US economy avoids a recession.³ If that’s the case, then with the economy as resilient as it appears to be and the Fed poised to cut rates,⁴ the backdrop for equities over the next year is likely strong.

Well, that wasn’t helpful

Why am I talking about cutting rates? Wasn’t January’s US Consumer Price Index (CPI) hotter than expected?⁵ It was, although a 3.1% yearly advance in headline inflation does not suggest to me a lack of price stability. Rather, it indicates that a few components of the consumer basket, such as Owners’ Equivalent Rent (which no one actually pays) remain sticky. Here’s a few price-related stats that may ease concerns:

• US inflation expectations (3-years ahead) are at 2.4%.⁶
• Only 22% of small businesses surveyed have plans to raise prices, down from a 50-year high of 66% last March.⁷
• In China, the world’s second-largest economy, prices have fallen over the past year.⁸
• Natural gas prices have plunged.⁹
• US Core CPI excluding shelter (which tends to lag) is up only 2% over the past six months, annualized.¹⁰

Get ready for a two-handle on inflation!

It’s that time again?

I’ve been willing to die on the hill that presidential elections don’t matter nearly as much for markets as people suspect. I have the charts to prove it. Nonetheless, I’m still often asked to make sector or industry calls based on the election outcome. The challenge is that the “obvious” sector or industry calls are often wrong.

For example, when Donald Trump won in 2016, many thought that would benefit traditional energy over clean energy, and the opposite was expected when Joe Biden won in 2020. The reality was that clean energy outperformed meaningfully under Trump, while traditional energy outperformed meaningfully under Biden.¹¹ Most people didn’t have that on their bingo cards.

It was said

“We do not consider politics in our decisions. We never do. And we never will.” – Fed Chair Jerome Powell¹²

I’m always being asked in election years about the politicization of the Fed. Inherent in the question (particularly this year) appears to be a concern that Jerome Powell and the Federal Open Market Committee (FOMC) would conspire to lower interest rates to support Biden’s re-election chances. The fact that Powell and two other members of the FOMC were appointed by Trump does not appear to enter the thinking.

Admittedly there is past precedent for a politicized Fed, but you’d likely have to go back a half century to when Richard Nixon told his Fed Chair that he was “counting on you, Arthur (Burns), to keep us out of recession.”¹³ I see no evidence of this again in the past 50 years. For example, did Alan Greenspan, a lifelong Republican and known Ayn Rand devotee, willingly lower interest rates in 1995 to help Bill Clinton win the 1996 election? Did Ben Bernanke, who was appointed by George W. Bush, keep interest rates at zero from 2009 to 2012 to help Barack Obama?

The Fed does not take their independence lightly. I’ll rest assured believing that policy will be set based on the Fed’s dual mandates of price stability and full employment, and not on who they prefer occupies the executive branch of government.

Since you asked

Q: Are you concerned with US credit card debt now at all-time highs?

A: Collectively, Americans now owe over $1.1 trillion on their cards, and the average balance per consumer is up to $6,360, both historic highs.¹⁴ Surveys suggest that this is not the result of consumer profligacy, but rather the higher costs of day-to-day expenses.¹⁵ That was to be expected given the inflation in 2021 and 2022. It suggests that there are pockets of the American population who are becoming overextended.

However, Americans are being reasonably steady in paying their credit card bills on time. In the fourth quarter of 2023, the delinquency rate (at least 30 days past due) of credit card loans from commercial banks was 1.36%, according to an average from Bloomberg. That's up from 0.98% at the start of 2023 but well below the 2.70% average from the start of this century. It’s likely the result of consumer fundamentals remaining reasonably strong. For example, the ratio of household debt service payments to disposable income remains well below the long-term average.¹⁶

In short, the truth isn’t as scary as the headline. Nonetheless, consumer spending is likely to slow in the coming quarters. That’s not necessarily the worst thing in the aftermath of an inflation scare.

Phone a friend

The “Magnificent 7” continues to lead the market. Do you see any catalyst for this to change? I posed the question to Alessio de Longis, Head of Investments for the Invesco Investment Solutions Team. His response:

“The US market, in recent decades, has tended to go through boom-and-bust phases. Many catalysts can break these market dynamics, and of course we think about the usual suspects such as interest rates, growth, inflation. However, often these catalysts can be unexpected and even unrelated to the market in question. Therefore, it’s worth thinking outside of the box to consider the potential impact from other markets and economies and understanding that markets are globally connected.

Here’s a thought. What if the Bank of Japan begins raising interest rates for the first time since 2007? Investors, for nearly 20 years, have grown used to borrowing in Japanese yen at low interest rates to invest in other assets that promise higher returns. A reversal in rates could spark margin calls and unwinding of positions, resulting in investors having to sell the winners, such as the Magnificent 7. The Bank of Japan could still manage this gracefully but, if you’re asking for an underappreciated catalyst, then an unwind of the yen carry trade is a reasonable candidate for unexpected market volatility.”

Automate my job?

Each month I pose a question to ChatGPT — the artificial intelligence-driven chatbot — and assess the response.

Q: How does the end of the “Nifty Fifty” trade of the 1960s and early 1970s compare with today’s environment?

A: Both periods saw a concentration of investor interest in a select group of high-growth stocks...

The Nifty Fifty was characterized by a narrow focus on a specific set of large-cap, high-quality companies with seemingly unstoppable growth trajectories. Investors were willing to pay premium prices for these stocks based on the belief that their growth would continue indefinitely. However, when the broader market experienced a downturn, many of these stocks suffered significant declines.

Today, we see similarities in terms of investor enthusiasm for certain high-growth stocks, such as those in the technology sectors.

Not bad, ChatGPT. I’m surprised that you didn’t also acknowledge that the recession of 1973-1975 ushered in a prolonged period of stagflation and a structural bear market.¹⁷ In this instance, the “high-growth stocks” appear to have made it through the 2021-2022 inflation and rate-hiking environment without significant impact to their business models.

On the road again

My travels this month took me to Broward County, Florida, to meet with financial professionals. Coming from New Jersey in February, I almost didn’t recognize the giant yellow ball in the sky. I congratulated one of our clients on his child being admitted to New York University. His response saddened me, but unfortunately didn’t surprise me. “I don’t think I can send my child to Manhattan, given the current state of the city.” Mind you, this conversation came the same week that I allowed my 16-year-old daughter and her friend to attend the Knicks game at Madison Square Garden by themselves. 

Granted, I don’t live in New York City anymore (the allure of the suburbs called), but I still spend much of my waking hours here. The crime-ridden dystopia that I frequently hear of is not remotely my experience. There are still very few places where I would rather pass my time. And lest I be accused of wearing rose-colored glasses, I’ll go to the stats, as is my wont. Crime in New York City in 2023, compared to 1990 and 2001, was down 71% and 22%, respectively.¹⁸ Don’t believe the hype!

See you in March. The longer days are coming!