Volatile From The Inception
In the sci-fi movie “Inception”, Leonardo DiCaprio’s character (Dom Cobb) and his team are hired to plant an idea into the mind of a corporate heir in order to break up a conglomerate. If they fail, or get stuck inside a dream layer too deep, they risk losing their grip on reality. Likewise, both stock and bond markets seem to be searching for the most likely reality going forward. Volatility has increased recently as investors attempt to measure and forecast the reality of AI expansion and economic growth coupled with sticky inflationary trends and future interest rate levels.
Since the mid-term election night, markets have been swinging around. In the last five trading days, the S&P 500 Index has seen a negative 4.4% day and a positive 2.4% day while the technology heavy Nasdaq Index witnessed a 5.5% down day and a nearly 3% positive day. Most days see a less than 1% swing. The AI investment dream had posited that the returns and productivity benefits would eventually outweigh the investments and risks associated with building out AI infrastructure. That dream was interrupted with the backlash against unchecked data center buildouts expressed during the recent mid-term elections in several states. Hundreds of billions of dollars in spending are still slated over the next several years for AI infrastructure, but that may be stretched out or even slowed down due to permitting delays, moratoriums and higher costs. Potentially slower AI buildout could actually benefit hyperscalers and companies with data centers already in progress.
Don’t Look Up
As we found out yesterday, consumer prices climbed notably again in October from the previous month, extending the stretch of stubborn inflation that contributed to voters’ sour economic mood in last week’s elections. Inflation for October came in hotter than expected, with consumer prices excluding food and energy rising 0.3% from a month earlier. For consumers, the cost of most essentials climbed. Grocery prices jumped the most since April, while a gauge of housing costs contributed to most of the rise in inflation. Electricity prices jumped 0.9%, and motor-vehicle insurance prices advanced by the most in more than a year. Toys, smartphones and baby formula also rose.
The Bureau of Labor Statistics did not publish year-over-year inflation changes because data collection was interrupted last October during the government shutdown. But some estimates put the typical basket of goods about 3.3% more expensive this year. It is the last Consumer Price Index (CPI) report Fed officials will see before their early December policy meeting, cementing expectations for a rate hike to counter inflation. The question is by how much.
One Battle After Another
Democrats’ broad victories included overwhelming support from voters who considered the economy a top issue. Many said they want to see action on core pocketbook issues such as grocery prices, gasoline and healthcare. The ability of Congress to deliver on lowering costs might be limited, at least in the near term. Democrats have said they may target rolling back the Trump administration’s tariffs and pressuring it to end the Iran war, which could offer some relief.
In general, the Fed has more power to shape the inflation trajectory by raising interest rates to lean against economic demand. However, the Fed has been fighting this battle to bring core inflation down toward 2% for many years post-pandemic. The Fed raised rates in September for the first time in three years. Although it skipped a rate increase last month, officials have signaled another hike is likely in December. Recently, the 10-year U.S. Treasury yield climbed back above 5% for the first time since late October. That breaks a period of calm for the bond market, which had benefited from a recent selloff in technology stocks and drop in oil prices, both of which reduced bets on interest-rate hikes by the Fed. Now, investors are convinced that the central bank will raise rates next month and next year as well.
Current expectations suggest a roughly 85% odds of a quarter-point increase by the Fed and a 15% chance of a half-point increase in interest rates in December. Federal Reserve Governor Michelle Bowman warned yesterday of a potential correction in equity valuations if returns on AI investments fall short of expectations. That is not new news, but Bowman also reiterated support for an interest rate hike amid persistently elevated inflation. Some might prefer the Great Gatsby over the Revenant movie, in which Leonardo DiCaprio is mauled by a bear. Hopefully the Fed does not push rates too far in the bear market direction. Many technology stocks, down 20% or more, are already there. Stock market futures are indicated up 1-2% today, continuing a volatile trend.
Demi Moore turns 64 today, Stanley Tucci turns 66, and Leonardo DiCaprio turns 52 today. Thank you to all that have served our country on this Veterans Day. The bond market is closed today.
Christopher Crooks, CFA®, CFP® 610-260-2219