An inflationary boom would be awesome!

I’ve finished my Florida rounds this week, with numerous meetings in Sarasota.  Business is booming there, as new establishments pop up quickly. Once just a “retiree” destination, the state of Florida is establishing metro areas outside the large cities. When asked “How’s business?” one advisor after another says “Great!” Even “Phenomenal!” I heard tales of new-business windfalls as small business owners—ranging from farmer to defense contractor(s), even medical clinics—cash in. Speaking of phenomenal, on a total return basis the S&P 500 rose 3.2% in March, its fifth straight month of gains. Over that time, it has risen 27%, a 98th percentile outcome dating back to 1936. When the S&P rose that much over five months, it was up a year later more than 99% of the time (excellent odds), by 15% on average. The 11% Q1 gain is the eleventh-most since 1950. Strategas notes that in such years Q2 corrections tend to be mild and that generally (1987 aside) the year as a whole is positive. That said, presidential election years typically feature a correction of, on average, 15%. We’ve seen no more than a 2% downturn in the S&P 500 since the rally started last fall. Some 60% of S&P 500 stocks outperformed the index in March, while the equal-weighted index gained 4.5%, the first such monthly outperformance this year and a sign that broadening is underway. Value thrived while Information Technology underperformed the broader market. Earnings for the largest tech firms grew 68% in the fourth quarter year-over-year. This will make for tough comps, with earnings growth expected to slow to 15% by Q4.

The Fed(s) may be about to cut rates around the world. Eurozone inflation came in below expectations in March at 2.4% core and 2.9% headline, indicating cuts in June even if Powell and the FOMC hold off. Meanwhile, there are now indications of a manufacturing upturn globally. Sweden’s manufacturing PMI is now at 50 after 19 months of contraction. The global manufacturing PMI rose to 50.6 and Chinese manufacturing has surprised to the upside. EM central banks are already cutting, even as the BRICs are seeing manufacturing growth and new orders above 50 in the latest manufacturing PMI. The manufacturing PMI in Greece rose to 56.9, its highest level since February 2022. Rate-cutting in the face of improving growth?! Wolfe foresees a willingness on the part of central bankers to let their economies “run hot.” Here in the U.S., the Fed expects to taper its quantitative tightening program soon. Furthermore, the “Fed put” is back in play now that the policy rate is high enough to allow for cuts. Core PCE, the Fed’s favorite inflation gauge, offers favorable year-over-year base effects through May, but that starts to change thereafter. If the Fed doesn’t cut in June, tough back-half CPI comps make some wonder if it will postpone rate cuts until next year. Showing surprising resilience, while wages have increased, corporate revenues have risen faster. This has been good for profits, keeping unemployment low and a recession at bay. An inflationary boom!

Take a breath After the phenomenal run we’ve seen, this week’s volatility could be heralding that much-anticipated presidential election year correction. Strategas says there’s initial support at 5,050 on the S&P, followed by 4,850—prices seen this winter, in other words. However, Fundstrat notes that although the market has been choppy in the last few weeks, there remains “precious little” other evidence that would warrant a major selloff. So, let’s just take a breath, as Evercore ISI reminds us that the healthy state of the labor market coupled with productivity growth have increased potential output such that the economy should be able to grow more than otherwise without causing the Fed to hold off or re-igniting inflation. An inflationary boom would be awesome! Perhaps my favorite meeting this week started as the advisor related his breakfast conversation with his missus who asked about his day. “I’ll be meeting with a woman who has better shoes than you.” Good thing I wore my Christian Louboutins. They’re awesome!

Positives

Jobs boom The unemployment rate fell to 3.8%, in-line with expectations and down from last month’s 3.9%. The economy added 303,000 jobs, especially in health care (81,300) and government (71,000). Economists had predicted a much-lower 214,000, but some of the surprise was due to technical factors, including the pandemic, seasonality and weather. Still, labor force participation rose to 62.7%, and hours worked ticked up by a tenth to 34.4. The JOLTS report showed that the headline quit rate remained at 2.2% for the fourth straight month. This figure leads wage growth by roughly six months and suggests less upward pressure on wages ahead.

Manufacturing boom The ISM’s manufacturing PMI rose to 50.3 in March, ending a contraction that dated to September 2022. Twice as many purchasing managers said inventory is too low rather than too high, which implies strong factory production ahead. The ISM services PMI dropped to a still-expansionary 51.4. The prices-paid reading in the services report fell to its lowest level in four years. 

Productivity boom The ISM’s production index rose to 54.6, its highest level since June 2022. This suggests manufacturing productivity growth will be solid ahead. Furthermore, productivity growth should keep unit labor costs in check, which helps the bottom line. The expected PCE rate over the next decade is at 2%. (This would be awesome.)

Negatives

Energy boom (would not be awesome) Oil rose to $87 on the WTI as Ukraine continues to attack Russian energy infrastructure, defying the Biden Administration’s request that such attacks be suspended. Furthermore, Israel’s attack on Iran’s embassy in Syria increased the likelihood of further escalations between Israel and Iran. 

Working from home Construction spending fell 0.3% on the month in February, vs. expectations of a 0.7% increase. Single-family homes showed strength, rising 1.4%, as builders looked to meet demand in a still-tight housing market. Residential construction rose 0.7%, while non-residential declined. Total non-residential spending is up 14% on a year-over-year basis, though, spurred by a 32% increase in manufacturing construction—much of it due to government largesse.

Yield sign Total lightweight vehicle sales fell by 208,000 to 15.49 million in March, stated as an annual rate, erasing some of the increase seen in February. Light vehicle sales are now roughly back at the same level as last fall. 

What Else

Make politics boring again Payments for the Employee Retention Credit, a Covid stimulus program, are due to resume later this spring. $180 billion, or about 0.6% of GDP, may still be available, with final claims due by April 15 of next year. Payments had been suspended since last September due to fraud. In one instance, an inmate in California secured $550 million in false claims from prison. 

Pedal to the metal It being an election year, the Biden Administration has a student loan cut planned for July 1 and the Consumer Financial Protection Bureau is setting limits on credit card late fees. This comes as the Administration halts Strategic Petroleum Reserve replenishment, in a bid to keep the price of oil from rising further. 

What could keep the debt from rising Neither presidential candidate has evinced an appetite for deficit reduction. Congressional Republicans, however, can often be heard voicing this concern. In the event of a GOP sweep in November, it would be interesting to see whether populist budgetary indifference or fiscal conservatism prevailed. Among potential GOP targets in such a scenario: green subsidies, entitlements and even the Trump tax cuts.