Downshift in Inflation Pressures and Strong Earnings Breed Optimism

Thought to ponder…

“Adversity, illness, and death are real and inevitable. We choose whether to add to these unavoidable facts of life with the suffering we create in our own minds and hearts, the chosen suffering. The more we make a different choice, to heal our own suffering, the more we can turn to others and help to address their suffering with the laughter-filled, tear-stained eyes of the heart. And the more we turn away from our self-regard to wipe the tears from the eyes of another, the more— incredibly—we are able to bear, to heal, and to transcend our own suffering. This was their true secret to joy.

-- Dalai Lama, Desmond Tutu, and Douglas Carlton Abrams The Book of Joy

The View from 30,000 feet

Last week was another week of records for the major equity indices, with the S&P500 breaking to new highs and the Dow Jones Industrial Average (does anyone follow the Dow anymore?) breaching 40,000, bringing back memories of the David Elias classic book “Dow 40,000”, where he speculated that the index would punch through that number by 2016. New equity highs were tied to two important economic releases, each of which broke in Powell’s direction, pushing interest rates lower, and inducing the upward action Pavlovian Response of the equity markets to lower rates. The initial driver of last week’s equity rally was a cooler than expected CPI release. It wasn’t so much that inflation was put on ice as it was a relief that inflationary momentum of the first three months of the year seemed to subside. The other big factor was Retail Sales, which took nosedive, dovetailing with the recently released blog from San Francisco Fed, which calculated that excess savings from the pandemic is officially exhausted, and data released from the New York Fed that consumer debt and delinquencies indicated further consumer strain. The combination of the perception of softer inflation with consumption headwinds fed a narrative that the economy would slow enough to support rate cuts sooner rather than later. Although, the recent run higher in equity prices supports our bullish call on equities, we caution not to get overly enthusiastic about a week or two of data. We believe the path for inflation, rates and consequently the equity markets, will be contingent on three forces – Labor Markets, Housing and Energy – each of which have been showing signs of weakness in the last month. If weakness persists in these areas, the Fed will likely embark on a mild rate cutting cycle this year, or perhaps a more aggressive campaign, if weakness shows signs of snowballing. Although rate cuts could ultimately bring positive outcomes for equities, the path higher for equities could be riddled with significant volatility if growth expectations erode along the way.