The Cycle Remains Positive Despite Current Inflation Measures

The Cycle Remains Positive Despite Current Inflation Measures

February 21, 2024

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For the last few weeks, I have been talking about the “expected” pullback in the markets that seems timely in its occurrence. As of yet it really hasn’t appeared. It makes one wonder what the stock market knows that most investors don’t? There have been some landmines in individual names given that earnings reports can be less than stellar at any given moment, but for the most part we are seeing a greater than expected number of companies release positive earnings and guide higher moving forward than what had been expected. This has caused a number of pieces to be written in the press about the feared recession quite possibly being avoided and the interest rate cuts expected from the Fed being pushed from March to May or June and even some talk of no cuts at all.

It appears to me that the most important issue to watch is interest rates, and most specifically the 10-year US Treasury as it seems to be a quite reliable barometer of strength in the economy and a harbinger of inflation expectations. In the last few weeks, we’ve seen inflationary readings in the way of the CPI and PPI. Thomas Lee of FundStrat has dug deeper and seemed to find that these higher-than-expected numbers could be blamed on spiking car insurance prices and a few other standouts, but the fact remains that the 10-year interest rate is now above the dreaded 4.2% interest rate level and moving its way back up to 4.5%.

See below the current history of this bond interest rate and some lines that show where it could be on its way to:

Last week I warned that there is a need to be cautious due to these rising yields. As seen above, the next stop would appear to be up around the 4.58% level. This is quite an increase from the lows seen less than a month ago and therefore has a tendency to let a bit of air out of the stock market balloon. Continued economic strength seems to be the reason for this action. On one hand this could be good as it could mean that there is broad improvement in the global economy (ex-China and Japan). The global composite PMI indicated the strongest growth in eight months last week, with leading indicators pointing to more upside in the coming months. According to Ned Davis Research, reduced risk of a sustained global economic slowdown, or even worse, a global recession, supports the continuation of the cyclical bull market in global equities. They believe that as I had stated above, the number one risk continues to be associated with monetary policy. What I mean by this is that the Fed is in a really tough spot. If they are late to party in cutting interest rates, this could cause the US economy to have a greater propensity to enter some type of recession, but if they cut too soon, particularly with inflation measures continuing to show inflations persistency, they could run the risk of cutting too much or too quickly and end up reengaging another inflationary period. 

In considering the recession watch probability, it is clear that we are not entering a shockwave type of environment like the Great Financial Crisis or the Pandemic, even though we have just gone through one of steepest interest rate hike cycles in recent history. In the Wall Street Journal this past weekend, there was an article titled, “The US Economy Is Unlikely to Stumble.” The article primarily focused on the retail sales report for January and how it was quite tame as compared to the CPI & PPI. They showed that food services and drink places continued to show increases and reflected an increase of 6.3% as compared to January of 2023. This again supports that point I continuously touch on, that there is still so much liquid, idle cash sitting on the sidelines prices are almost sure to remain high. I believe this has been the backbone of the resiliency of the consumer economy in the face of the Fed’s tightening.

Enough said about the two opposing fears: inflation and higher rates or recession and economic contraction. In looking at the US equity market, the two issues that I have touched on are:

  • The normal, seasonal digestion that tends to occur after President’s Day Holiday and end in the later part of March.
  • The measurement of breadth of advancing market issues. Where the small-cap Russell 2000 index exhibits action showing it joining their larger company brethren in the S&P 500.

The Russell 2000 seems to be continuing to bump its head on a higher level but can’t seem to decisively move above this point. It could be that the regaining of energy in the S&P 500 might be necessary after its must deserved rest.

In looking at the broad market S&P 500, I think that the severe selloff that was seen last Tuesday was some healthy profit-taking, but not a sign of a significant market top. It is still too early to call any kind of a top for the first quarter, it would require a much broader and more inclusive decline. Interest rates could mean either that the economy is still plenty strong and therefore companies’ futures should be respected, or that the Fed is in an impossible quandary where lowering rates could not be seen as the positive it is hoped to be. This week should prove quite interesting as one of the most highly followed semiconductor companies comes out with earnings just after you receive this note.

All this being said, the last few weeks have not really given us a lot of new information to chew on.  So, I will leave you with the major points that we follow in determining our asset allocation decision. This is sort of a bullet point list of what we are currently seeing:

I know that there will always be things popping up that can cause markets to change, but at present these are the biggest issues that seem to be top of mind in today’s environment.

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Important Disclosures: 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. 

Investing involves risks including possible loss of principal.

The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The Nasdaq-100 is a large-cap growth index. It includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.