Weekly Investment Update (02/16/2024)

Hotter than expected inflation data caught investors off guard earlier this week. However, the negative reaction from both stocks and bonds proved to be short-lived. Perhaps most importantly, market leadership remains consistent with economic expansion. On an equal-weighted basis, consumer discretionary stocks continue to outpace consumer staples, transportation stocks are outperforming utilities, and small cap stocks are pushing to new year-to-date highs. Thus far, we are not seeing a shift in market leadership that would indicate a persistent concern about an imminent recession or still higher interest rates.

In part, investors may have found comfort in comments made by Federal Reserve Chair Jerome Powell during a closed-door meeting with House Democrats after the inflation report was released. Powell downplayed the January inflation reading, stating it was “consistent with what they had been anticipating.” Assuming that is true, the January CPI report will not change the Fed’s view on the dominant trend of inflation, which we continue to believe is lower. If economic growth remains stable, easing inflation and eventual rate cuts (regardless of the precise timing) should provide support for stocks as we move through the rest of 2024.

Disinflation Trend Continues, Though With Bumps in the Road

What is happening: Despite some signs of annual easing of inflation in January, monthly increases for both core and headline accelerated more than in December and surpassed consensus forecasts. Headline CPI declined from 3.4% year-over-year (YoY) in December to 3.1% YoY, while core inflation held steady at 3.9% YoY. Inflation continues to be driven by sticky shelter and services prices, while deflation in goods prices offset some of the overall increase. Shelter prices accounted for the largest portion of the monthly gain, with the owners’ equivalent rent component increasing to a nine-month high. Price gains across services were broad-based with increases in areas such as medical care and transportation services.

Why it matters: While the inflation report triggered market concerns, the annual numbers still show that the longer-term disinflation trend remains in place. As we have noted, the last mile in disinflation is typically the most challenging. Moreover, while seasonal adjustments attempt to reconcile companies setting higher prices at the start of the year, these adjustments are far from perfect and can lead to increased volatility in the January inflation print. As Chicago Fed President Austan Goolsbee noted earlier this week, it is important not to judge the inflation trend on one datapoint, and the Fed’s 2% target is based on PCE, which often differs from CPI. Notably, shelter costs comprise 36% of the CPI but only 15% of the PCE index. In terms of implications for monetary policy, we believe Powell is looking to for inflation simply to continue its current downward trajectory, making large improvements unnecessary. Consequently, we believe one firm report will not deter the Federal Reserve from cutting interest rates, likely starting this spring.

U.S. Retail Sales Decline More Than Expected as Higher Interest Rates Permeate the Economy

What is happening: The value of retail purchases in January, adjusted for seasonal factors but not inflation, fell by a larger than expected 0.8% from December. This was the largest drop in nearly a year and surpassed economists’ predictions of a more modest 0.2% decline, following a downwardly revised gain of 0.4% in December. The Commerce Department survey showed that nine of 13 spending categories declined in January, suggesting broad-based weakness. Notable weakness was seen in building materials, stores, and auto dealers. One bright spot in the report was spending at food services and drinking establishments, which rose 0.7%, indicating the consumer maintains a recent preference to spend on services rather than goods.

Why it matters: After a summer and fall of robust consumer spending that helped support the U.S. economy, the larger than expected decline in January sales and downward revision of the December number suggest some slowdown. The survey’s seasonal adjustments are designed to take into account the swing from holiday spending in December to the January lull. That said, the data series can be notoriously volatile, especially during the winter months given weather conditions, so some caution in extrapolating trends is warranted. The coming months will be critical in determining whether the slowdown in spending is indicative of a weaker than expected economy. Evidence that the consumer is slowing will be an additional impetus for rate easing in our view.

Bessemer portfolios have positions in Chipotle Mexican Grill, Costco, and Walmart, which we believe are positioned to benefit through pricing power as they gain wallet share from consumers looking to trade down to more attractive price points amid a slower growth backdrop.