Markets have been hinging on employment and inflation reports for months now, causing ripple effects on every tenth of a point in either direction. A tame, but positive, stock and interest rate response to December’s update yesterday was about the only shock provided relative to the wild swings usually accompanying the releases. Generally, money flowed out of last year’s winners (Staples, Healthcare and Utility stocks) and back into beaten down growth names. Beyond Meat, Peloton, Warner Brothers, American Airlines, Expedia#, and Ford are now up 15% – 30% already this year. Stable earners like Pfizer, AbbVie, Lockheed Martin, CVS# and Coca Cola are down 3% – 7%. Interest rates wobbled for most of the day before dropping by 10bps later in the trading session.
For the first time since early 2000, a month-over-month decline in prices was reflected. This was led primarily by energy costs as gasoline and fuel oil showed double digit declines. Good news, but unlikely to be repeated on a continuous basis. Another sizable drop was seen in used car prices. Recall that during the pandemic, new car supplies came to a halt, which helped drive up the cost of used cars. This was the first inflationary shoe to drop. Now that used car prices are seeing ~14% declines relative to last year, it should be treated as a precursor to normalcy. Auto loan rates approaching double digits are sure to crimp sales as well.
On the flip side, our Summer drought is keeping food prices elevated, especially for eggs which are up 60%. Apparel prices are also still strong, counterintuitive to the discounts everyone is now promoting. These two categories will reverse in the near future. Lastly, rents are still robust, at least according to lagging data that the BLS uses in their calculations. In the real world, rents have been coming down for months now. This should hit CPI reports during the Spring, helping to push them even lower. Higher prices result in lower demand over time. With new supply coming to market in the multi-family and apartment complex sectors, effective rents should show sizable drops later in 2023. Below is the “real world” action:
This report was mostly good news, at least for trend lines. However, CPI is still at a stunning 6.4% yearly gain, a far cry from a 2% target. Markets cheer the trend and hope our Fed recognizes that inflation will keep coming down, leading to an end to this Fed tightening phase. However, every Fed official is preaching higher for longer. Another 25bps increase is all but guaranteed on February 1st. Hawkish rhetoric will follow. In this instance, the higher stock and bond prices go, the more likely that this Fed will continue their aggressive actions. They do not want inflation to come roaring back. While 25bps is a slowdown in size, the battle is not won. Even if they believe that inflation is going to come down, expect more chatter about staying higher for longer and the conviction that more layoffs are coming. The Fed’s logic is that spending must be controlled, as anything that increases net worth (homes, stocks, bonds) is a precursor to more buying power and inflation. The Fed’s job gets increasingly harder every time stocks go up.
A strong January is usually a precursor to a positive year. So far, the bullish case is playing out:
1. Growth stocks are leading, especially the economically sensitive semiconductor sector.
2. Inflation is coming down at a nice pace and could be at the Fed’s target by late 2023 if rents cooperate.
3. Employment is holding up, yet wage gains are starting to slow, a real perfect storm. In the end, the Fed and consumers would prefer full employment with stable wage gains.
4. The U.S. dollar keeps dropping, helping competitive pricing for multi-national companies, which boosts their earnings power.
5. The consumer is holding up quite well. Q4 GDP looks like a solid 4% gain.
6. Interest rates peaked months ago, helping bring mortgages back under 6%.
7. Oil and gas prices are collapsing, which will help inflation and consumer spending.
8. The Fed is slowing their rate hikes and an end to the tightening phase is coming.
9. A soft-landing scenario is looking possible.
For now, the Fed is in control, but caution remains warranted. The bear case still could come through, though it could keep getting pushed out due to consumer balance sheets being stronger than usual due to Covid handouts and years of stock, bond and home price gains. The rebuttal for each bullish scenario, in order:
1. Growth stocks were crushed last year. This could be just a reversionary bounce back to fair value, not indicative of another new leg up.
2. It is easy to come down from multi-decade highs. It will be much harder to get to the 2% goal.
3. White collar layoffs are ongoing, while the service sector, especially hotels, restaurants and travel industries, will keep hiring due to being understaffed. A downturn in growth will bring forth more layoffs down the road.
4. Lower interest rates are helping drive the U.S. Dollar down. Who knows how long that will last.
5. Balance sheets are in good shape, but excess cash is clearly dwindling, credit card debt is already back to new highs, and more layoffs will cause the consumer to slow down.
6. While a positive for those taking loans, the bond market may be pricing in a more dire economic scenario and rates could come down even further in a hard landing.
7. Collapsing oil and gas prices could mean growth is slowing so much that oil demand is falling fast. Luckily, a warmer Winter is helping European supplies. Anyone good at predicting weather for the rest of the winter?
8. Some investors are not listening. This Fed will not change posture until something breaks. Rate cuts are many months away and will only come in 2023 if economic conditions dramatically worsen (hard landing). Stocks would be down well before that.
9. Every scenario is still possible, but until inflation gets to 2%, more increases and negative money supply are coming down the road. The lag effect of previous rate increases may be pushed out further than normal, causing a fake out.
Both cases are relatively reasonable. The result? It is tough to envision a massive move in either direction, but the Bulls are in charge so far. Bank earnings reports from this morning were decent for Q4, but guidance is a bit light. In this uncertain market environment, that is to be expected throughout earnings season. This makes those sky-high P/E stocks increasingly risky, especially following such a large bounce over the past few weeks. Individual stock picking is coming back to the fore. Valuations matter, as does cash flow and an ability to run your business without “free money.” Bounce backs in the most beaten down stocks/sectors are giving investors a chance to reposition into future leaders (look hard at those Beyond Meat type stocks that are bouncing if you still own them). An inverted yield curve could take longer than normal before causing a recession. There are pockets of opportunity, but follow the mantra “bulls make money, bears make money, pigs get slaughtered.”
Stock markets are closed on Monday in honor of Martin Luther King Jr.
For Friday the 13th, we have plenty of birthdays: Natalia Dyer from Stranger Things, 28 – Patrick Dempsey, 57 – Orlando Bloom, 46 – The next hockey Great, Conor McDavid, 26 – Shonda Rhimes, 53 – Julia Louis-Dreyfus, 62 – Michael Pena, 47.
James Vogt, 610-260-2214