Stocks rallied on Friday after a key inflation figure showed that the epic, post-pandemic price climb may be abating. Stocks are on the verge of breaking through a bullish, key technical indicator – what that means and more, in today’s note.
Take small bites. Inflation is cooling down. This, according to last Friday’s PCE Deflator release which showed that inflation cooled to +5.0% from +5.5%. If we look at the core number, which excludes food and energy, inflation eased to +4.4% from +4.7%. I bring up the core number because that is the Fed’s preferred inflation indicator. As an economist I understand why the Fed chooses to exclude food and energy in its analysis, but as an analyst, portfolio manager, and tax paying, voting CONSUMER, I am always dubious, as fuel and food make up a sizable part of most household’s budgets. Regardless, as investors, we know that the Fed has been raising interest rates because of that number, and it will likely slow down its hiking due to its recent easing.
Indeed, inflation has cooled somewhat but it is far from where it should be, and I am going to show you a long-term chart to prove my point, and more importantly, to make sure that you pay close attention, because while we are making progress, we are far from out of the woods just yet. It is clear that many of the supply chain problems that initially stoked inflation have eased somewhat. Fuel costs, also a key driver of inflation, have come down from their highs as the energy complex rushed in to even out supply in the wake of Russia’s invasion of Ukraine. On the other side of inflation sits demand. Consumer demand had been raging in late 2020 and 2021, a result of reopening and a flood of government stimulus. An epic supply chain choke combined with a stimulus-driven demand surge yielded giant-sized inflation. On the demand front, Friday’s Personal Spending release showed that spending declined by -0.2% in December after a downward revised -0.1% in November. People are spending less. That is good news for inflation and rate hikes, but not-so-good news for the companies behind all the stocks that we own. We are smack-dab in the middle of earnings season and the results so far show a clear pattern of compressing margins. Companies are missing on sales targets while narrowly beating on EPS targets, achieving this by cost-cutting measures. To be clear, sales and profits are still growing year over year, but it is unclear if that trend will continue. Check out the chart of the PCE Deflator then keep reading.
Inflation heading in the right direction has caused investors to speculate that the Fed will slow down its pace of rates hikes, which is a reasonable assertion given that the Fed is not eager to hike the economy into a recession. This speculation has also caused stocks to aggressively rally year to date. This recent, quick move higher after a year of painful declines sets up a key technical indicator known as a golden cross. A golden cross occurs when a 50-day Simple Moving Average crosses over a 200-day Simple Moving Average. If that cross over does occur with a few closes above, it is considered to be a bullish market signal. The last time we got that was in June of 2020, after which the S&P500 rallied by some +53% through its January ’21 highs (see chart below). Whether that occurs or not, we will have to see, futures are not pointing in that direction today, but the week ahead is chock-full of drivers which can push the markets in one way or another: The FOMC policy meeting along with the Chairman’s presser, monthly employment figures, lots of earnings, etc. The week ahead will be a busy one for market watchers. But don’t worry, I will keep you informed.
FRIDAY’S MARKETS
Stocks rallied on Friday after inflation numbers came in lower, as expected. The S&P500 gained +0.25%, the Dow Jones Industrial Average climbed by +0.08%, the Nasdaq Composite jumped by +0.95%, and the Russell 2000 Index traded higher by +0.44%. Bonds slipped and 10-year Treasury Note yields gained +1 basis point to 3.50%. Cryptos added +0.48% and Bitcoin gained +0.05%.
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