Stocks soared at the open yesterday after a favorable CPI report showed inflation slowing. Markets then faded as investors realized the good news by itself would have no bearing on pending Fed policy. By day’s end, gains were minor and inconsequential. Now traders await the conclusion this afternoon of the FOMC meeting. A 50-basis point increase in short-term rates is a foregone conclusion but the future path of rate increases isn’t. Everyone will focus on any nuance regarding forward guidance emanating from Chair Powell’s post-meeting remarks.
The fact that inflation is receding wasn’t in doubt. The small 0.1% increase in headline CPI month-over-month was a bit better than previously anticipated, mostly due to a sharp drop in energy related costs. Services related items were still uncomfortably high. Shelter costs remain extended as well. There is little question that these will come down in coming CPI reports. For whatever technical reasons, there is a lag between slowing rents and the way shelter cost changes are calculated in the CPI report. Thus, inflation is clearly on its way down.
Mr. Powell’s job today is to make sure investors realize two points. First, lowering inflation for goods is much easier than lowering services costs. A half-done job isn’t a completed job. To get services and wage demand under control requires higher rates and more time. Second, while the pace of rate increases is going to slow starting today, the Fed isn’t exiting the fight any time soon. Inflation has to get low and stay low for that to happen. Of course, the Fed realizes that price stability is only one of its mandates. Economic growth and full employment are the others. Crushing inflation at the expense of the economy isn’t a good solution. Indeed, that explains the slowing pace of future rate increases. As market watchers look to the Fed today, the only serious question is how many future increases are necessary. Most agree, for the moment, there will be one more in February, probably 25-basis points. Beyond that is a guess. It’s a guess for the Fed and it’s a guess for investors. For all the guesses and all the CNBC interviews on the subject, no one has a crystal ball clear enough to tell us what policy steps will be needed beyond February. Decisions to be made at the mid-March meeting will be totally dependent on the courses of the economy and inflation between now and then.
As long-term equity investors, the real question is how relevant is any of this. If a serious and/or elongated recession is in front of us, it matters quite a bit. However, that doesn’t seem likely. The same can be said if inflation persists at elevated levels despite tight monetary policy. But if we face an economy growing close to 1% or falling 1-2%, how good companies operate won’t change. Managements today are much more cautious about hiring than they were six months ago. At the same time, they are loathe to fire quality, experienced workers knowing how tough it will be to rehire or replace them. They will absorb the extra costs for a brief period. Those with solid balance sheets will be looking for ways to gain advantage over weaker competitors. Blocking and tackling. That’s what the best managements do well. There are always challenges. The economy is just one of them. Changing rules and regulations are others. Competitor actions often require reaction. Successful R&D leads to new products and opportunities.
There is also a realization that no product or service can grow at high rates forever. Two decades ago, joining Facebook was the rage. Today, the site loses users faster than it can sign up new ones. Is there anyone left without a laptop or a smartphone? But with that said, Apple keeps showing users how to do more things with their phone. Just look at the growth of Apple Pay.
When it comes to demonstrating enduring competitive advantage, I always turn to McDonald’s. Mickey D’s did not invent the hamburger. Nor did it invent the $0.15 burger. What it did was introduce a quality product backed up with quick service and consistency across all stores. Then it added on. The Big Mac. Egg McMuffin, Kids meals, playgrounds, drive-thru windows. The App and rewards programs. At the same time, it was making improvement to kitchens to attain both consistency and delivery speed. Kiosks replaced order takers. The only assurance I can give you about the future is that more changes will come. As for its competitors, they keep trying to catch up. McDonald’s still has only a tiny share of the food eaten away from home business. Time has eroded some of the good ideas of the past. There are fewer playgrounds and Kids Meals today. The McDonald’s customer has aged over time, but management rarely loses focus and it adapts. During Covid, dining rooms were shut but drive thru traffic soared. The focus shifted to drive thru speed. I use McDonald’s as an example because it is easy to understand, but there are dozens more operating in very diverse business arenas.
As investors, you still need to pay attention to stock prices. Even McDonald’s gets overvalued at times. The best buy moments are when great companies hit a pothole. If you drive in Philly, you try to avoid the potholes, but you can’t avoid them all. When a great company misses earnings by a penny or two, see why. If it’s a pothole, step in. But make sure it’s a one-off event, not a game changer (e.g., losing market share to a better product) or an early sign of maturity.
It is likely today that markets will be rather volatile between the time of the Fed’s press release and the close of the market. Volatility could spill over to tomorrow. But will anything said or done today shift the economic winds measurably over the next year? Probably not. Keep focusing on upgrading your portfolios with companies capable of enduring growth over time.
Today, former FBI Director James Comey is 62. Former tennis star Stan Smith is 76. Today, he is probably better known for sneakers than tennis.
James M. Meyer, CFA 610-260-2220