Weekly Investment Update (01/12/2024)

This Week’s Views and Positioning

As noted in our 2024 outlook, we expect to see progress toward lower inflation this year even as the path will likely be bumpy. We discuss recently hotter inflation data in more detail below, with a key observation being that the strength in CPI was concentrated in shelter and used vehicle prices — two areas where leading indicators are clearly pointing toward future price weakness. Therefore, our outlook for monetary policy has not changed, and we believe the Fed will deliver interest rate cuts this year.

Although we anticipate stops and starts relative to the market’s confidence around the path of inflation, we think important underlying trends remain intact. For example, additional labor market weakness will be important to support improved investor sentiment around equity markets. Further rebalancing of the labor market is critical to a continuation of slower wage growth, which is needed to push currently sticky services prices lower. Initial unemployment claims this week indicate that the labor market remains quite strong; however, weakness under the surface gives us confidence that additional softening is likely. For example, all the recent gains in private payrolls have been concentrated in just two sectors: professional and business services and education and health services. It will be important to monitor trends in the labor market as too much weakness would be problematic, but for now we see a helpful mix of softness and stability.

Path to the Federal Reserve’s 2% Inflation Target Continues to Be Nonlinear

What is happening: Headline and core inflation surprised to the upside in December. While year-over-year headline inflation accelerated to 3.4% from 3.1% the month prior, core inflation eased to 3.9% from 4.0% year-over-year. Headline inflation has eased notably from 6.4% a year ago. Inflation pressure continues primarily to be driven by shelter, contributing to half of the monthly increase for headline inflation. Core services excluding shelter prices similarly remained elevated, maintaining November’s pace of a 0.4% month-over-month increase. Additionally, core goods prices picked up slightly due to an increase in prices for used cars and apparel.

Why it matters: One data point does not make a trend, and we expect the disinflation process to continue even though the path toward the Fed’s 2% target is likely to be bumpier and the pace more gradual this year relative to last year. The overall move lower in inflation over the last 1.5 years has been, in part, driven by the decline in goods prices. However, looking forward, this category is likely to contribute to volatility of monthly readings given the magnitude of price declines thus far.

While CPI was hotter than expected, other inflation indicators, such as the producer price index (PPI), came in below expectations, conversely driven by declining goods prices. Shorter-term annualized headline and core inflation rates, such as the three- and six-month rates, remain below current year-over-year rates, an encouraging sign that momentum is slowing. Given continued disinflationary momentum, interest rate cuts are likely to be made before the Fed’s 2% inflation target is reached, especially as the Fed has recently stated it will be more accommodative and cognizant of the risks to growth. For more details please see our latest Quarterly Investment Perspective, which addresses our outlook on inflation in more detail.

Market Technical Indicators Have Improved in Recent Months

What is happening: Market technical indicators have improved in recent months as softer inflation reports and a cooling labor market allowed the Federal Reserve to shift its messaging to a more dovish tone. Volatility metrics have eased from elevated levels with equity market volatility now around its post-pandemic lows and Treasury market volatility moderating from its early 2023 highs. Moreover, the AAII Bullish investor sentiment reading has improved to 48.6% from 29.3% at the end of October last year, indicating an unusually high level of optimism among retail investors. Commodity Trading Advisors, or investment managers that invest in derivatives, have increased their aggregate equity market risk to 66% over the past several months, up from a level of 4% in early November. Positive positioning and sentiment indicators have benefited equity prices, with 77% of S&P 500 companies now trading above their 200-day moving averages.

Why it matters: Positioning and sentiment indicators are at more elevated levels, with some stretched to the positive side, suggesting a risk of a near-term pullback. Counterintuitively, volatility can increase when market sentiment and positioning are overly positive as investors may be more sensitive to downside surprises in data releases and, in turn, look to take profits.

While the more stretched technical environment could increase volatility in the short term, fundamentals matter more in the long term. Bessemer’s portfolios remain overweight equities relative to fixed income despite some possible short-term volatility given that the longer-term fundamental backdrop of the U.S. economy appears healthy and should support future company earnings growth.