We can live with this

The S&P 500 has been sideways for a while now, something often seen in the weeks after a presidential inauguration; only half of the names in the index currently trade above their 50-day moving average. For the market to exit this period of consolidation with any bullish conviction, that fraction will need to increase. The market has absorbed its share of bad news well lately, with DeepSeek and tariffs causing only brief grimaces so far. Tech has traded sideways this year on ho-hum earnings, and yet that has not sent the market lower either. Taken together, maybe this means the market isn’t as stretched as commonly supposed. The NYSE advancers vs. decliners ratio is below its late-autumn highs, which is too bad since that metric offers good guidance of market activity over the next quarter or two. Still, the strength in Financials gives confidence. As well, profits breadth has improved over the last several months. The AAII’s survey of bearish sentiment rose to its highest level since November 2023, generally reckoned a contrary indicator. That proved to be a good inflection point as the market rallied higher. Corrections, when they arrive, tend to come from upturns in interest rates or unemployment—or else from something exogenous. So far, so good. We had unpleasant news about inflation this week, but the market sighed and carried on. Maybe investors were relieved to see that the Fed didn’t respond by floating a rate increase. One of my sources pointed out that while interest rates are mainly driven by inflation and employment news, “Chairman Data-Dependent and President Tariff” can add to the volatility of the journey. Clever, I thought.

Is Jerome Powell following the dubious path of Arthur Burns in the 1970s? In that “dismal decade,” then Fed Chair Burns called victory on inflation three times, reducing interest rates, only to see a resurgence of inflation three times, resulting in his dismissal. The path of CPI since its 9.1% peak in June 2022 has eerily declined and paused as in the early 1970s. A stubborn resurgence of inflation today would be right on pace. A patient Powell seems to be advised. One key difference between now and then is that inflation expectations remain tethered. Combining this week’s U.S. CPI & PPI data, the headline PCE price index (the Fed’s preferred measure) is expected to have increased 0.3% m/m in January, suggesting lingering inflationary pressures but consistent with an extended Fed pause. Piper Sandler posits that the past four years’ very aggressive monetary and fiscal stimuli are the root causes of today’s sticky inflation; the Fed’s easing cycle further aggravated sticky prices, as did the 15% y/y increase (!) in October through January federal outlays. MIT also highlighted that the 50% surge in federal outlays over the prior five years was the key reason for inflation. Sticky suggests patience is advised.

Although the murky inflation picture may suggest that policy errors up and down the National Mall could bring on a downturn, there is actually cause for thinking that we’re in pretty good shape. The recent upturn in the long-suffering manufacturing sector, together with ongoing strength in services, suggests that the economy is not preparing to roll over but, rather, just getting going. Currently, 60% of US PMIs are in expansion, something not seen in two years. This is likely to continue to improve, given the economic benefits of the Fed’s rate cuts and hopes for a new, deregulatory agenda. We’re also starting to see improved earnings expectations at small and mid-cap companies. Firms that showed strong upward earnings revisions have been market leaders over the past quarter. Also, early-cycle sectors are showing an increase in employment. Still, impending tariffs are likely to pull some activity forward, muddying the waters. Still again, global manufacturing growth is improving, too, with Japan and the UK, and even France and Germany looking less sleepy lately. All told, a Fed on pause (or even done cutting rates) is something we can certainly live with.

Positives

• Business is booming The latest earnings season has nicely surpassed expectations. Analysts started the year expecting Q4 2024 S&P 500 EPS to increase 8.2% y/y in Q4 2024, but actual results are now looking to be up 14.8% y/y. Indeed, nine of the 11 sectors are exceeding both sales and earnings estimates from the start of the quarter.
• Business optimism still booming The NFIB Small Business Optimism Index slipped 2.3 points in January from its six-year peak, to 102.8. While still historically strong, seven of the ten underlying components declined. Capital expenditure intentions saw the most significant pullback, dropping seven percentage points to 20%, the steepest monthly decline since 1995, and coinciding with the Fed's pause in rate cuts. The uncertainty indicator jumped 14 points, the largest monthly increase in 40 years. Still, firms are maintaining strong confidence, with 47% expecting economic improvement, near two-decade highs. NFIB is a good proxy for middle-income consumer confidence, itself a tell for broad consumer spending.
• Not bad at all … The headline Producer Price Index decelerated to a 0.4% increase in January from 0.5% in December, slightly above expectations of a 0.3% increase. Core PPI inflation ticked down 0.1% to 3.4%, remaining roughly stable since last May. Core PPI, excluding food, energy and trade services rose 0.3% over the month in January, also above consensus (0.2%). Importantly, the details that feed into core PCE were soft – health care components were flat to slightly negative and domestic airfares declined nearly 1% m/m. Together, the CPI and PPI imply that the Fed’s preferred inflation gauge, core PCE inflation, fell from 2.8% to 2.6%, not far from the Fed’s 2.5% year-end estimate. 

Negatives 

• … Though it does appear progress on inflation has stopped January CPI came in hotter than expected on almost every metric, with core CPI rising 0.5% m/m vs consensus (0.3%), a notable acceleration from recent months. There was striking strength in CPI core services ex-housing, leaving no progress year on year. This may reflect start-of-the-year price resets and seasonal adjustments. Interestingly, surprises to CPI over the last 25 plus years have been more likely to be biased to the upside in the first half of the year than in the second half. January’s release has seen the largest number of beats (50%) and the lowest number of downside misses (15%). Nonetheless, in his semiannual testimony to Congress, Fed Chair Powell remarked that "the labor market is very strong" and that the Fed is in “no rush” to cut rates. Elsewhere, import prices rose 0.3% in January, slightly less than expected, but export prices soared 1.3%.
• Consumers spending less Retail sales and food services declined 0.9% m/m in January, much weaker than consensus (-0.2%). The control group, which feeds into the consumer goods portion of GDP, fell 0.8%, vs. expectations of a 0.3% increase, reversing December’s 0.9% gain. Weather may have been a factor, although nonstore retailers saw a 1.9% plunge, the sharpest one-month drop since 2021. Spending expectations have dropped across all income cohorts. This makes sense, as the Atlanta Fed’s Median Wage Tracker hit a fresh low of 4.1% in January.  Meanwhile, within the recent New York Fed survey of consumer expectations, the mean probability of losing a job over the next year rose to 14.2%, the highest since July and the median expected spending growth for the year ahead declined to 4.4%, a fresh cycle low.
• Governments spending less; industrial production down too Government spending is likely to be less of a push than it was in 2024, especially across state and local governments. From Pew, “According to new data released by the National Association of State Budget Officers, total general fund spending is expected to decline to $1.22 trillion, a more than 6% drop from estimated levels in fiscal 2024.” Industrial production rose 0.5% in January; though driven exclusively by utilities output, up 7.2% with a frigid January. Mining and auto production fell 1.2% and 4.9%, respectively, each seeing the fourth drop in the last five months. 

What Else

What’s so special about 2% anyway? Progress toward the Fed’s 2% inflation target has stalled. But Wolfe Research notes that 2% is a widely agreed-upon fiction among both policymakers and market participants borne out of a New Zealand central bank paper from the late 1980s. Ironically, the target was only invoked when inflation was serially below 2% in the aftermath.

The devil’s in the details Trump wants to eliminate pennies, because each cost the US Mint 3.69 cents to produce last year, wasting $90 million. However, removing the penny from circulation increases demand for nickels, which cost 13.8 cents each to produce!

Why the long face? In response to bird flu and rising egg prices, Waffle House announced that it’s adding a 50-cent surcharge for each egg ordered. Turning to TV for a laugh? The total volume of comedy TV series produced in the US and Canada is down 39% since 2019.