Flash — I am going to keep my note short and just address yesterday’s CPI release. I will likely post a follow-up after the FOMC meeting.
So, Tuesday was the big December CPI release that the market was anxiously anticipating, looking to get important clues regarding what Chair Powell and Gang may do the next day at the FOMC meeting, the minutes, the “DOTS,” and his press conference.
As the equity market spiked up just after the CPI was announced, I got several messages from clients that are more bullish/dovish commenting about how positive the data was, and they were letting me know that I might be wrong to keep being concerned about the Fed and for the possibility of higher rates. Inflation is clearly dead, the Fed is finished, and this almost certainly leads to much higher equity prices.
Over the last several months, I have been the ever-hated in-house bear, on both the equity markets and my forecast that has had the Fed going higher for longer. There has been a lot of lively discussion and debate, both internally and externally, regarding both topics.
For me over time, I don’t make a lot of pure macro-only calls, but from time to time my work suggests that I should be more vocal as I was during most of 2022. I am more process and model/indicator driven with earnings-estimate revisions and profit cycles having a heavy influence on my recommendations. Price action and positioning are things I look at, and I have indicators that monitor them for both potential tactical and medium-term impacts. With that being said, these tools do not overly dominate my research, but I also don’t want to be overly stubborn or willfully ignore market shifts in either direction.
Let me answer the following question:
Brian, the inflation data was soft and you have been “wrong” since the October lows. Has your conviction level for your unfavorable equity outlook changed? Does this alter your view that the Fed is still likely to go higher for longer and are you finally ready to throw in the towel?
Answer: NO to both based on my work.
At the risk of being overly stubborn or refusing to see the obvious I remain in exactly the same place that I have been for the last six months, which is:
- Considerable downside equity risk remains.
- The Fed’s terminal rate is still expected between 5.25-6% NOT below 5%.
- Earnings expectations remain too high.
- Valuation levels still need to be adjusted lower to a backdrop that has higher inflation, higher rates, higher risk premiums, lower profits growth, lower valuations, more economic uncertainty, a weakening labor market, fewer corporate share buybacks during the year ahead, and a high bar to get a return of monetary stimulus.
- Bottom line: it is not time to pop the cork on the champagne bottle just yet, but rather investors should be on full alert for a continuation of rocky seas.
Yes, the data undeniably showed that CPI inflation is indeed moderating, and the peak clearly is behind us. Kudos to those, including my colleague Tom Lee, who forecasted that today’s number would come in below expectations.
From my work, I have been totally in agreement that CPI had seen its peak AND that the data would and will continue to show that the trend is lower. The bigger ongoing issues are: Will it continue down towards target, and how much more policy is needed for the Fed to get to 2%. The decline from roughly 9% in June to 7% yr/yr as per the CPI release was the easy part in my view.
The initial spike in the inflation data was initially caused by the start of Ukraine/Russia geopolitical issues and its impact on commodity prices, which then spilled over into other things and helped the inflation genie who was already trying to escape its bottle during the latter parts of 2021. Thus, the move to 9% was obviously an overshoot that was going to be unsustainable and would have likely slowed from a rate of change basis simply by commodities consolidating to more reasonable levels.
I had several great dialogues this morning with my inner circle of experts who I use as sounding boards and sometimes they end up being at the receiving end of my market frustrations. One shared with me a great analogy that I really liked, and I am going to share with his permission (thanks RG).
Yes, inflation is down off its peak, but let’s put this in perspective that CPI still stands at 7.1%. Let me write that figure again and highlight — 7.1%. If I told any of my clients one year ago that inflation in December 2022 would be running at that level and asked them the following questions – 1) where do think interest rates would be; and 2) would you be bullish or bearish, I am confident that the answers would be rates higher than where they are today and bearish. The end point to the Fed’s inflation fighting journey is 2% and the move from 7% to 5% will be harder than the first two hundred basis point decline, and the decline from 5% to 2% will be even harder still.
Hence, Chairman Powell and Gang may be considering reducing the flame that is heating the water-filled pot that contains the frog, but if you were the frog, are you feeling overly joyous knowing that the boiling point has just been delayed and not being out of the pot? And to make sure the metaphor is clear, the boil is the final terminal rate for the Fed funds rate and the frog is the economy.
More after the FOMC meeting and press conference.
