The Weekend Edition # 150 - Talking about Inflation Again?

Welcome to another issue of the Weekend Edition!

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Here's what we cover

• Market Recap - ATHs

• Macro - Inflation Again?

  • Inflation Expectations

• Closing Thoughts - A Decent Start to Earnings Sea …

• Calendars

Market Recap - ATHs

07 Oct - 11 Oct, 2024

US Markets continue to hit all time highs. We’ve just started earnings season and solid reports from the financial sector are definitely helping. XLF had its best day since November 2023, underscoring the market’s resilience.

Hedge funds are increasingly highlighting the renewed interest in old economy sectors like industrials and utilities, driven by AI-led capital expenditures and rising electricity demand. This shift has been a catalyst for these sectors, with companies like Fastenal seeing notable gains—up 10% after reporting solid earnings this morning. It’s clear that while some headwinds persist, there are powerful tailwinds driving specific pockets of the market.

US markets will operate on Monday, Columbus day, but we don’t have any major companies reporting earnings.

Macro - Inflation Again?

It’s become uncool to talk about inflation. With the way the Fed has shifted the narrative and shined the spotlight on the labor market, it would seem that “inflation has been conquered” is now a foregone conclusion. The Fed’s mandate is not “either inflation or the labor market”. It’s both and it’s really a little surprising that they are looking at these two factors in such a binary way.

The last two weeks have shown us that - the labor market is far more resilient than everybody’s been thinking and inflation has not really been conquered, as yet. Prices continue to weigh on people, and if people are losing their jobs, it’s even more imperative that we deal with higher prices.

Let’s take a look at where things stand. The chart below is one I update every month. I take the numbers from the BLS and color code them. So the color gradient is applied over the past one year, to show whether the numbers are increasing or decreasing on a monthly basis. And then the last two columns show the YoY change in inflation from one month to the other. I’m not going to analyze the chart because I think the colors make it easy to read. We’re not cooling down as we’d hoped.

With the US economy slowing, but not exactly to recessionary levels (regardless of the reason), the Fed’s aggressive rate cutting projections just may bring back inflation particularly now.

Why now? Well, there are a few things that continue to weigh on my mind:

• China’s stimulus measures - While the measures may not be enough for China to completely jumpstart consumer spending and fix the ailing property market, it may be just enough to push up commodity prices. We’ve seen a preview of this over the last few weeks with copper, agriculture, and other base metal prices spiking.

• Global Trade Routes Being Disrupted - First Europe, and now the Middle East. Nothing seems to be subsiding. If anything things are getting worse, and we are seeing disruptions in trade flows. The spike we saw in oil over the last couple of weeks was based on this. We already have disruption in the Bab El Mandeb Strait, i.e., the Red Sea. GS says oil flows are down -40% since the disruptions began. And then there is the bigger threat of the Strait of Hormuz, through which almost 20% of the world’s oil consumption passes. A block here could send Brent reeling above $100/bbl.

• US Natural Disasters - Unfortunately, the US has been hit by multiple natural disasters over the last several weeks. Not to mention, port disruptions and labor strikes. All of this adds up, and it could mean disrupted supplies and higher prices.

• US Elections - I’ve said this before - both candidates have policies that are inflationary. On the one hand, we could see higher tariffs that could very well lead to higher prices (actually it definitely will). On the other hand, we have higher tax burdens for companies, and I find it hard to believe that some of that will not be passed on to consumers in the form of higher prices. There is also the issue of reshoring being advocated by both candidates. While this will likely add more domestic jobs, it will also increase the prices of products. It remains to be seen how this works out but, in many cases, it may lead to a period of higher prices.

• US Housing - Yes we saw a slight improvement in the monthly trajectory of shelter inflation but, the rate of deceleration still remains very sticky. Here’s another interesting fact: despite the Fed’s jumbo cut, the US Mortgage Rates have started to increase again. Long-term yields are rising, partly because of the uncertain environment, partly because the economy is stronger than expected. While Chair Powell is content to ignore the housing situation, saying that rents will reduce at some point, the question is at what point? The shortage of housing isn’t magically going to be fixed.

Inflation Expectations

This week the University of Michigan’s Consumer Sentiment Index for early October 2024 showed a slight decrease, falling to 68.9 from September’s 70.1. This drop was unexpected, as economists had predicted a rise to around 70.8. Despite the decline, the sentiment is still significantly higher compared to last year.

What’s interesting is that long run inflation expectations continue to remain stable, but short run inflation expectations did increase. People are still a little worried about rising prices, but most importantly election uncertainty.

“While inflation expectations have eased substantially since then, consumers continue to express frustration over high prices.” - UoM Survey

Closing Thoughts - A Decent Start to Earnings Season

The banks delivered a decent start to earnings season. JP Morgan was certainly upbeat, delivering Net Interest Income (NII) higher than expected and raising guidance for NII as well. Looking through the release though, we see that there is some increase in Card Provisions, deposits have reduced and loan growth hasn’t necessarily been at a rapid pace. This is for the consumer and commercial banking division, i.e., smaller players.

Dominos and Pepsi also had a slower start. Pepsi discussed geopolitical tensions weighing on them globally, while Dominos talked about the slowing consumer in August. They are particularly worried about the lower income consumer and the increase in discounting.

The blended earnings growth from FactSet shows a 4.1% YoY increase. But FactSet’s headlines read: S&P 500 Will Likely Report Earnings Growth Above 7% For Q3! With solid earnings growth, stretched valuations should improve. However, while we have a decent delivery of numbers, it’s important to continue to look through the earnings to understand the nuances and the trajectory of the economy.

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

Calendars

US Earnings Calendar

US Economic Calendar in Eastern Time (Source: Trading Economics)

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.