US Strategy Weekly: Beneath the Headlines

Inflation

The financial press reacted to February’s CPI report this week with headlines like: “Gasoline, shelter costs boost US prices; inflation still slowing.” This may be part of February’s inflation story, but not all of it. Headline CPI rose 3.2% YOY in the month, higher than consensus expectations, and up from the 3.1% pace seen in January. Core CPI rose 3.8%, down slightly from the 3.9% seen in January, but still higher than forecasts which expected core inflation to ease to 3.7% YOY.

Housing, which has a 45.2% weighting in the CPI, rose 4.5% in February and transportation, with a 15.7% weighting in the index, rose 2.7%. In the post-COVID economy, travel and entertainment have been booming. This means food away from home, which is 5.4% of the CPI index, is relevant to most consumers. It rose 4.5% YOY in February. In addition, the Federal Reserve has stated they are most concerned about service inflation. In that regard, “other goods and services” which is 2.9% of the index, increased a hefty 4.7% YOY in February. However, these were some of the most concerning components of the CPI. Many other components of the CPI grew 2.7% YOY or less. See page 3.

Economists can take solace in the fact that most major inflation indices are decelerating. The pace of prices for headline, core, services, and owners’ equivalent rent of residences, in the CPI are trending lower. However, many segments of the service sector are not. In recent months we have pointed out the huge rise in motor vehicle insurance prices and this continued in February. There are also rising trends in hospital & related services, medical care services, and services less rent of shelter. Since most of these services are household necessities, rising prices in these areas impact most consumers and are most damaging for lower-income families. See page 4.

From a forecasting perspective, we are most anxious about healthcare. Healthcare pricing has been muted for most of 2023 and in fact prices were declining for the overall medical care index with an 8.02% CPI weighting, and particularly for the medical care services category (a 6.54% weighting). These declines helped contain core CPI in recent months. But this appears to be changing and healthcare prices are now rising. See page 5.

Moreover, while prices for “rent of primary residence” are increasing at a slower rate, prices for tenant & household insurance, fuels & utilities, and water/sewer/trash collection services are now trending higher. The increase in these services explains why many consumers remain worried about inflation and are not responding favorably to the slower pace of headline inflation or solid GDP reports. It also explains why the Fed is focused on service inflation which tends to lag goods inflation. These underlying trends also suggest that inflation may be more difficult to manage than many economists expect. In this case, Fed Chairman Jerome Powell may be right by attempting to dampen expectations of a fed rate cut in the near future.

The impact of inflation is seen in many parts of the economy. The NFIB Small Business Optimism Index fell to 89.4 in February, marking the 26^th consecutive month below the 50-year average of 98. The survey was generally weak, and most components moved lower in the month. Not surprisingly, inflation was noted as the single most important business problem according to 23% of small business owners, up three points from last month, and now replacing labor quality as the top problem. See page 6.

Consumer Credit

We also read headlines about January’s consumer credit outstanding which highlighted January’s annualized growth rate of 4.7% for the month — an acceleration from a downwardly revised gain of 0.9% in December — that mirrored other positive economic data from January. In simpler terms, total consumer credit grew by $19.5 billion in January, to $5 trillion, but this was a 2.5% YOY pace and down from the 2.6% YOY rate seen in December. Nonrevolving increased $11.1 billion in the month, which was a 0.5% YOY increase, and revolving credit grew $8.4 billion, which was an 8.8% YOY increase. But more importantly, all these YOY rates are decelerating sharply from a year ago. It is curious to us that the press would suggest credit expansion is accelerating when it is clearly decelerating, particularly nonrevolving credit. Perhaps more importantly, the senior loan officer survey indicated that banks are planning to tighten credit standards beginning in the first quarter.

It is also interesting to see that the federal government is now the second largest owner of the $3.7 trillion in nonrevolving consumer debt. The government currently owns $1.48 trillion of nonrevolving consumer credit, which is largely student loans that originate from the Department of Education. See page 7.

Fundamentals No Longer Matter

Although February’s inflation report was disappointing, the equity market shrugged it off this week. We are not surprised since economics and fundamentals do not matter in a bubble. We are amused by the many discussions in the financial media about whether the current stock market is a bubble or not. Few of today’s prognosticators have lived through a bubble, and even if they had, a bubble is nearly impossible to analyze. But in our view, this is a bubble, perhaps best exemplified but the massive move in Bitcoin. Both equities and bitcoins are being propelled higher by the popularity of ETFs which is this bubble’s form of financial leverage, in our opinion. Nonetheless, it is prudent to point out that the S&P 500’s trailing 4-quarter operating earnings multiple is now 24 times and well above all long- and short-term averages. The 12-month forward PE multiple is 21.3 and when added to current inflation of 3.2% sums to 24.5. This is well above the top of the normal range of 23.8. See page 8. By all measures, the equity market is at valuations seen only during the 1997-2000 bubble, the financial crisis of 2008, or the post-COVID-19 earnings slump. Still, prices could go higher since those previous market peaks hit sums that were well above 30!

Technicals: all good except for dow theory

There is plenty of good news on the technical front. The 25-day up/down volume oscillator reached 3.47 on March 12 and is overbought for the first time since early January. This oscillator needs to remain in overbought territory for at least five consecutive trading days to confirm the new highs in the indices, but this is the best performance we have seen in over two months. See page 11. The NYSE cumulative advance decline line has made a record high confirming the market highs. The 10-day average of daily new highs is currently at 511 and above the 500 level that we like to see on new market highs. See page 12. Last week’s AAII readings showed bullishness increased 5.2% to 51.7% and bearishness rose 0.5% to 21.8%. The 8-week bull/bear spread rose to 20.8% and is back into negative territory of 20.6% or greater. However, sentiment indicators tend to be early warning signals and are not good at timing peaks or troughs in the market. The only negative one can point to in the technical arena is Dow Theory. The lack of a new high in the Dow Jones Transportation Average is, to date, a nonconfirmation.

Gail Dudack

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