For those of you who would prefer to listen:
It’s been quite a start to the year for the Market. What a difference 2 months makes. Nobody wanted stocks as 2022 concluded. Sentiment was so sour. Inflation was crippling. A recession seemed imminent. That attitude sure has dissipated. Is it warranted? Let’s dig into that.
Investors sent inflation and recession concerns to the back burner again in response to the firmer US Economy in the young year. Unemployment just hit a new 5-decade low and January retail sales exceeded expectations in nearly every category. Americans who want a job, pretty much have a job. And they keep spending. This is definitely not recessionary behavior, which has kept the Market buoyant in 2023 after a brutal 2022.
Of course, this is rearview mirror stuff. What matters most is where we are headed. As Mr. Gretzky poignantly pointed out, the key is to skate to where the puck is going, not where it’s been.
The fact is inflation is still running hot. It has certainly cooled from the boiling point last year. But the elevated temperature is keeping the Fed firm on more rate hikes. We got fresh data this week. The Consumer Price Index (CPI) and the Producer Price Index (PPI) were the big events. Neither was particularly good. The inflation report was largely in-line for consumers but hotter than expected for producers. Higher costs for producers generally result in higher costs for consumers. It’s only a matter of time. Companies try to pass those costs on. So, a higher PPI often leads to a boost in CPI.
Headline CPI increased at a 6.4% rate from a year ago. This was a little higher than expected and less of a drop from December’s 6.5% increase. It’s still well below the peak inflation of 9% reached last year, marking 7 straight months of decline. Shelter, food, and energy costs were among the biggest drivers of higher costs. Housing accounted for nearly half the increase. The price for used cars, airfares and medical care all declined last month. This report, which came Tuesday, seemed somewhat better than feared given whispers of hotter inflation.
The Market took it very much in stride. The Fed has noticed this disinflationary trend but has admitted the process will be choppy. The Market understands the lagging impact on sticky inflation. The CPI report gave some more oxygen to the “soft-landing” case. In fact, we’ve been hearing increasing voices for “no-landing,” meaning the Economy will continue to grow and avoid recession. The Stock Market seems to reflect that thinking. The Bond Market does not. More on that below.
January headline PPI increased 6% from a year ago. The kicker was the monthly increase which was 0.7%, nearly double the 0.4% expected. On top of this, December PPI was revised to just a 0.2% decline after the initial read indicated a decline of 0.5%. Goods prices saw the largest monthly increase since June of 2022. That was the top. Producer Price Inflation has stopped going down from that excessive 2022 rate. It’s now going back up. That’s not what the Fed wants. That’s not what anyone wants. The Market reversed gains into losses in response on Thursday.
The situation now sees strong consumer spending, a low unemployment rate and inflationary pressures perking up again. Fed Chair Powell has made it crystal clear that it is committed to taking inflation back down to its 2% target. It’s a long way from there, and now going in the wrong direction. Consumer spending is the economic engine, accounting for 70% of GDP. Consumers are definitely taking on more debt, but they’re still spending. Americans now have more debt than they had pre-Covid. In fact, credit card balances are up a staggering 22% from last year alone. That debt has become more costly as interest rates have risen. A resilient Economy means more rate hikes. More rate hikes increase the likelihood of a Fed policy error by choking off growth. The best tool the Fed has is to force job cuts and slow the Economy. That’s what they’ve been trying to do. It’s not happening as fast as they wanted, which has them a bit perplexed.
The Bond Market has moved quite a bit of late. The 6-Month Treasury yield cleared 5% for the first time in years, indicating the Fed’s rate hike campaign ain’t done yet. The Market had previously priced in actual rate cuts by year-end. No more. The risk is decisively the Fed doing too much. Up until Thursday, the Stock Market had been ignoring all this, with increased calls for a no-landing situation. Speculative stocks have been leading the charge. Realistically, a no-landing scenario is just a soft or hard-landing yet to happen. It just pushes it out. With 5-decade low unemployment, a recession just might be a 2024 thing.
The Fed is losing an important voice. Vice Chair Lael Brainard has been selected by the White House to head up the National Economic Council. Brainard was known as one of the most “Dovish” members of the Fed, touting a somewhat less aggressive approach in the fight against inflation. She has advocated for slowing the pace and intensity of rate hikes. Brainard has been a counterweight to the vociferous Fed “Hawks.” The Fed is losing a Dove while the Hawks get more aggressive.
Corporate America keeps sending signals of how things are. The Coca-Cola Company is a barometer for the state of global commerce, with business in pretty much every country on Earth. This week, Coke said it sees its commodity costs slipping to the mid-single-digits later this year. That supports the disinflation theme the Fed has sought. In 2022, higher costs for things like sweeteners and aluminum drove a high-single-digit increase for Coke’s commodity basket.
Unlike most companies, Coke has some serious pricing power. They proved it last year and proved it again this week. The company’s key measure of adjusted organic revenue growth easily beat the Street expectations on the back of strong demand for Coke Zero and their coffee beverages. Revenues grew 15% in Q4. That said, price hikes accounted for all of the growth. The volume of beverages sold actually contracted in the quarter. People paid more for less. That was a big theme last year, where only the best could raise prices without shrinking demand. But even the Real-Thing gets caught with inflation.
Back to the Market: The Bulls have been increasingly focused on a “no-landing” theme supported by low unemployment and a resilient Consumer. The Bull case was infectious. The herd is no longer worried. That’s not necessarily a good thing. Sentiment has proven to be an effective contrarian indicator. Bank of America’s Global Fund Manager Survey for February showed investors were the least pessimistic since February of last year. We all know what happened after that. 2022 happened. Recession odds from the survey fell to just 24% in the next 12-months. That is down from a 77% peak in November. Fear has definitely abated.
Bulls in the US Investor’s Intelligence poll hit 48.6% this month. That is the highest since the final 2021 reading. That was the Market top before the 2022 Bear took hold. Bearish sentiment has fallen to 25.8%, well below the 44.1% early October reading. That was the Market bottom. As you can see, investors tend to chase. They get excited at tops and freak out at bottoms. It is time-tested. It’s also the opposite of what investors are supposed to do. Buy low and sell high in theory, is buy high and sell low in reality. That’s not the way. There’s nothing like price to change sentiment.
Also important to point out: 2023 brought a bit of a “garbage” rally. The stuff that got beat up the most, mainly speculative unprofitable stocks, have led the charge in the young year. Short-covering has been a big part of it. Speculative call options buying has too. The rally broadened out to be sure, with wide participation. But the leadership has been decisively speculative. The rally has no doubt confused the Fed. One strategist on the Street said the Market is taunting the Fed. It’s actually hard to disagree with that. It’s a recipe for the Fed to punch back with a ½-point hike ahead. The Market is now seeing that.
Enjoy the ride. Enjoy the green while it lasts. We anticipated a strong start to the year. We didn’t expect it to be this strong. We also expected continued volatility. That we can count on. The Bull-Bear brawl continues. The Bull took the upper hand to start the year. The Bear just struck back. More time is needed to see it play out. Patience is needed too. So, hang in there. We’ve got this. We know what to do.
Finally, I had the privilege of speaking to the Campolindo High School investment club this week. It was an energetic and intellectually curious crowd. I must say I was beyond impressed. Investing in a better tomorrow is Bedell Frazier’s professional purpose. Investing in the next generation is a large part of that mission. I walked away feeling invigorated about our future.
Have a nice weekend. The Market will be closed on Monday in honor of Presidents’ Day. Our office will be closed as well. We’ll be back, dark and early on Tuesday.
Mike
