The rally goes on as all the leading averages moved to new highs last week. For the NASDAQ, it has been three years since its prior high during the speculative SPAC and IPO fever of 2021. Bond yields held steady.
Looking for news this week, the focus will be on economic data from February, usually one of the slowest months of the year. All indications are that while the pace of the economy is slowing a bit, it is still growing. According to the real time GDPNow website of the Atlanta Fed, Q1 growth is on track to increase by 3%.
While growth continues, inflation continues to normalize, albeit at a slower pace than some had hoped for. Markets now predict the pace will slow enough to allow the Fed to cut short-term rates by up to a full percentage point by the end of the year. For the last several weeks, the Fed and markets have been in synch about the pace of future cuts. Thus, with growth continuing and inflation moderating at a pace both the Fed and markets have adjusted to, what seems to be moving markets ahead is a shift of funds from cash and equivalents into stocks. The fear of missing out is a catalyst for that shift and will be until, for whatever reason, markets find a cause to shift direction.
As noted last week, one possible catalyst might be the February CPI report due out on the 12th of March. Expectations are for moderation from a surprisingly hot January report, but when it comes to government monthly statistics, you never know what’s coming month-to-month. A lot of attention focuses on the housing component which makes up over 40% of the core CPI number. That continues to run hot. Higher interest rates over the past eight weeks and renewed strength in the price of single-family homes may keep that number hotter than some expect for at least a few more months. Rents had started to turn down last fall, and with a lot of new supply coming to market this year, expectations were for further moderation. But that doesn’t seem to be happening. Rents aren’t strong to be sure, but they have stopped declining across a wide swath of the country. But apart from shelter costs, what many economists have not been focusing on is the ongoing persistent strong increases in service costs. That wasn’t just a January event. If you recall, within the January numbers, I listed about a dozen items from haircuts to car insurance that were rising at a 6% annualized rate or greater in January. Collectively, those will have to moderate before the Fed reduces rates.
That is why the first cut, which some had expected this month, may not come until summer. However, with that said, the real question for investors should be, “Do we care?”.
Real interest rates have been increasing for months with little apparent effect on economic growth. To be sure, real rates have impacted the sale of existing homes, and higher credit card balances are likely to start pinching consumers soon. But malls are still busy, people are traveling, and there has been little noticeable decline in restaurant activity. If, despite the higher rates, business continues to be solid and consumers remain active, there would seem to be little reason for stocks to start declining. Ultimately, rates will come down, inflation will moderate and, hopefully, growth will continue.
There is still some concern that a recession has simply been delayed and not averted. That’s a counterfactual that one can neither prove nor disprove at the moment. All we can do is watch. It’s a bit like Chicken Little. Those expecting recession has been screaming for months only to be forced to defer the apparent onset to a later date.
2024 is a Presidential election year. This year, the twin focus of the campaigns is likely to be the economy (always number one) and immigration. As to the economy, it depends on where voters look. If the eye is on job security, that favors the incumbent. Unemployment is low and layoffs are rare. Unions are regaining power in a tight labor market and wages are up. But if the other eye is on inflation, the Democrats and Biden have a problem. Even if the pace of inflation moderates, to most consumers the damage has been done. Virtually everything is much more expensive than in was in 2020 and voters will lay that at the feet of all incumbents.
As for immigration, the obvious focus is on our southern border. The bad news is that it seems to be wide open. Over 2.4 million entered our country last year and were released into the American diaspora awaiting a hearing that may never happen. The good news, at least from an economic standpoint, is that over 3 million more people are living, eating, and working in America than a year earlier, including those who entered through normal legal channels. It isn’t upon me to debate immigration policy. But I will note the economic advantage that occurs as a result of today’s policy or non-policy. It’s an important reason why growth has been surprisingly healthy.
Speaking of foreign impact, one also must consider the deflationary impact of lower import prices excluding oil and other commodities. A principal reason is that China is manufacturing far more than it can consume internally leading to a renewed flood of exports. Nations around the world, including the U.S., are taking steps to avoid Chinese dumping of goods onto our markets. That is most apparent in the auto industry where cheap Chinese electric vehicles have been unable to gain a foothold. But recognize that economic growth in China is slowing, forcing the government to support exports to keep growth from falling further. President Biden is taking some steps to moderate the impact. Trump, if elected, would likely do more. But in the meantime, the decline in import prices is helping to slow inflation, which is a good thing.
Thus, the economic data supports rising equity prices. However, after four straight months of gains, valuations look stretched. A modest correction would be a good thing. When that might happen is a debatable question, but nothing goes up in a straight line forever.
Today, actress Catherine O’Hara turns 70.
James M. Meyer, CFA 610-260-2220