Mission accomplished?

Risky words to utter, as President G. W. Bush knows all too well Adjusting for inflation, the S&P 500 posted 21% gains in 2023. Such numbers don’t look at all pre-recessionary. Indeed, those gains may be so healthy as to contribute to the wealth effect. That’s all fine unless it leads to inflationary behavior. This may be where we are: Progress, but not too much progress, please, lest we reawaken inflation. Two steps forward, one step back. Perhaps the fact that the all-time high was last set two years ago – so far all we’ve done is recover lost ground – will keep the splurging at bay? Let’s hope so. Per Fundstrat, expect new all-time highs this month. After falling 20% and then retracing to within 1% of the all-time high, in 12 out of 12 instances since 1950 (pretty excellent odds!), the market has gone on to make new highs by the following month. Furthermore, there’s plenty of fuel to keep this going. Nearly $6 trillion sits in money market funds. Put me in, coach! This at a time when the AAII’s sentiment survey shows retail investors are very bullish, though that can be a contrarian indicator. The bullish thesis presumes multiple Fed cuts (more below). The CPI gave pause on that but then the PPI came to the rescue (more below).

However, the market moves with earnings. Fourth quarter earnings got underway today, with large banks giving a mixed report but saying current interest rates are helping profitability. One school of thought says it’s hard to see how earnings rise materially from here without a jump in oil prices (i.e., from a China boom – not from geopolitics!) or else cost cutting. Going into earnings season, negative pre-announcements were at a three-year high though, as is often the case, lowered expectations may mean an earnings beat should be within reach. It’s an election year, and the Biden Administration will seek to use the levers it has available in order to keep the economy from stalling. I, for one, will not underestimate the levers. Capital expenditures were strong in 2023 fueled by the CHIPS Act and the Inflation Reduction Act. But 2024 is another story as capex faces a cyclical decline.

Inflation measures dueled it out this week, with consumer prices rising and producer prices falling and everybody wondering what the Fed will do. With “soft landing” suddenly the new consensus, most now assume the only risk is that the Fed keeps the brakes on too long. That may be so, but there is a possibility that, Terminator-like, inflation comes back for another go. This is a view I’ve seen voiced by JPMorgan, Gavekal, and BCA Research, among others, but it’s been drowned out by the recent euphoria. As a child of the 1970s, I suspect that the still-tight labor market keeps wage growth stickier than expected. So-called supercore services (ex-energy and housing) remained stuck at a high level in the latest CPI report, rising 0.4% from the month before. Consumers’ disposable income has outpaced inflation since mid-2022. Furthermore, some $400 billion remains unspent from savings built up during the first year and a half of the pandemic. So the American consumer still reigns supreme but will need to hang onto a job to stay that way. The labor force has grown very little in the last decade and productivity growth has been muted as well. Until AI! Thanks to AI and other "Roaring 2020s” innovations, Yardeni sees the productivity growth rate doubling between now and the end of the decade, reaching 3.5-4.0%. That would keep unit labor costs down, saving the day on inflation. The Atlanta Fed’s wage growth tracker continues to be stuck at a high level, 5.2% in December. In the view of BCA Research, that number will come down this year but only at the price of a recession. Maybe, but the “quits rate” has come down. That tends to be a leading indicator that wages are coming down. We believe the Fed is laser-focused on the labor market. An advisor I met with this week said, “The market presumably is forecasting six cuts, but I don’t know anyone who says six cuts.” Neither do I. ISI says that at 2% core inflation, six cuts would indeed be appropriate. 2% … hmm. That would be “mission accomplished.” Risky words.

Positives

• Mission accomplished? Producer prices as measured by the Producer Price Index (PPI) fell by 0.1% last month vs. a predicted uptick of 0.1%. PPI inputs are used in the PCE, which is the Fed's preferred inflation measure, a good sign for continued disinflation. 
• The Fed has its eye on the job market Weekly jobless claims dipped to 202,000. This is the lowest level in the data since October, and definitely not reflecting a weakening job market. A rise to 210,000 had been forecast. 
• Right, but for the wrong reasons? The trade deficit fell to $63.2 billion in November vs. projections of an increase to $65.0 billion. Sounds good, but the cause is attributed to soft demand, likely a result of the Fed’s tightening campaign. Exports also dropped a bit; central banks have hampered demand internationally as well. 

Negatives 

• Don’t celebrate too soon! Consumer prices rose more than 0.3% last month and 3.4% from the year before vs. a forecast of 0.2% and 3.2%, hotter than expectations. The increase for core CPI was 0.3% on the month, as expected. Interestingly, some 38% of CPI components rose by 0.3% or more from the month before, nearly double the rate of the past decade. Still, this report featured the first sub-4% print for core CPI since 2021. And housing should fall further as the government’s inputs come back into balance with market-priced rents.
• The costs of small business are on the rise Per this week’s NFIB small business survey, small business’ interest paid on loans rose from 9.3% in November to 9.8% in December. Meanwhile their hiring plans index fell from 18% to 16%. The NFIB reported better-than-expected confidence, but that level remains well below its long-term average. 
• When do delinquencies become a real problem? Consumer credit rose by nearly $24 billion in November – much more than expected. It now stands above $5 trillion for the first time ever. 

What Else

Freedom of the seas Yesterday, the U.S. and the U.K. struck Houthi military sites in Yemen in a bid to protect freedom of travel in the Red Sea. A report from late 2023 indicates that 57% of Americans want the U.S. to play an active role internationally, down from 70% in 2018. It’s becoming clear that war fatigue and polarization, among other sources, have curbed many Americans’ comfort with foreign entanglements. The further course of American engagement abroad may await the outcome of this November’s election.

Office space Bank earnings may have been a mixed bag, but you wouldn’t know it from the elite office rental market. In Manhattan, a record 192 tenants signed leases in 2023 at or above $100 per square foot. These deals, the bulk of them with financial services companies, amounted to 26% of the total square footage leased last year.

Not where I’d pictured it somehow More than a third of internet traffic flows through northern Virginia, a holdover of the web’s infancy as a U.S. military project. Not everyone is happy about of it – complaints range from zoning to noise to environmental concerns – but the projects are popular with politicians.