For those of you who would prefer to listen:
Market turbulence is back. It returned with a vengeance this week. I last wrote on March 31st these words:
“The Market was running pretty hot heading into Spring. We could see a cooling off period before another run higher. It’s not a stretch to say volatility is likely to pick up as we head towards Summer. A lot of good stuff has been priced in from this rally. The Presidential election is heating up and we anticipate the road ahead to be quite bumpy. This Bull still seems healthy. It’s just getting mature. And the next stretch could definitely be a challenge.”
That was from our Spring Newsletter which went out last week. The road definitely got bumpy, fast.
There’s no one reason for the renewed volatility. It’s been a combination of things. Some the Market had been watching closely. Others have been completely ignored. Geopolitics fall in the camp of the latter. Inflation and interest rate cuts are the former. There’s a whole lot in between. I’ve long said that there is no shortage of material for me to cover on any given week.
Inflation has stalled. That was evident with the Consumer Price Index (CPI) report, released this week. CPI accelerated at an annualized 3.5% in March. It was a 3.2% run rate in February. As you recall, CPI is the official measurement of prices for goods and services in America. It’s not the Fed’s favorite inflation indicator. But it’s an important one. CPI reflects the prices we pay.
Both stocks and bonds sold off on the news. Yields rose in response to the higher inflation. Expectations of the Federal Reserve cutting interest rates keep shrinking. That was Wednesday. Thursday brought a different inflation metric. Wholesale sales prices aren’t climbing as fast as Consumer prices. The Producer Price Index (PPI) came in at 0.2% in March. It increased 2% year-over-year. That was lower than expected. That release took some of the pressure off the hotter CPI print. The Market liked that, responding with a rally that nearly erased Wednesday’s decline. Then Friday came.
Earnings Season kicked off Friday in usual fashion. It starts with the Big Banks. The early reports were generally beats. But the outlook for the rest of the year had a cautious tone. The University of Michigan’s monthly Consumer Sentiment report also reflects some economic angst ahead. The Market responded with more declines. And as the day went on, the selling accelerated. That’s not unusual price action for a Friday. But declines have been a bit unusual in 2024. All 11 of the S&P 500’s sectors recorded weekly losses. That hasn’t happened since September. Investors had been showing some signs of complacency.
Inflation is still a problem. We continue to experience it at restaurants and the grocery store. But it’s everywhere. CPI showed inflation has been a crusher in Rents and Insurance costs. Auto insurance is up a whopping 22% in the past year. There have been more car accidents. A report published by TRIP, a national transportation nonprofit research organization, found that traffic fatalities in America increased 19% from 2019 to 2022. In California, they were up 22%. Car crashes declined drastically during Covid for obvious reasons. But the re-opening of America has seen an increase in aggressive behavior behind the wheel. There was a 23% increase in speeding-related crashes and a 22% increase in alcohol-related crashes.
Car repairs have gotten a lot more expensive too. It’s all that fancy technology in today’s vehicles, the ultimate mobile device. Small fender benders can cost Thousands of Dollars. It’s also been rumored that Electric Vehicles are being written off (totaled) after mid-level wrecks, far more than gas cars. I haven’t been able to confirm this, but skeptics seem to believe it. On top of paying for the car fix, there’s also insurance. In California, the average Dollar increase is $585, and the average percent increase is 69% for those reporting an accident. Of course we’re all paying for others bad behavior. That’s inflationary.
Home insurance premiums have risen too. There’s been an increase in larger claims due to bigger, more expensive homes and climate-related disasters. Much of the new building has been in what’s perceived to be riskier areas that have experienced an increase in hurricanes, floods and wildfires. There’s also the issue of age. Many houses across the country haven’t received the maintenance needed to survive the years. There’s been an increase in leaky pipes and leaky roofs.
Owning a home in America has become cost-prohibitive for so many. Homeownership costs have surged with mortgages, insurance premiums, property taxes and maintenance costs showing little sign of cooling. Some insurers have made drastic changes. State Farm, the nation’s largest homeowner’s insurance company, stopped accepting applications in California. State Farm also dropped a large number of existing policy holders. That followed Allstate’s decision in 2022 to pause new homeowners’ policies in California to “protect current customers.” The cost to insure a home has increased while the number of companies willing to insure has declined. That’s inflationary.
The Fed is stuck. Inflation had been coming down, but it’s since stalled and is showing serious signs of reversing higher. Their 2% goal is looking increasingly further away. Of course, it’s down from the peak price growth of 9% in the Summer of 2022. But the “last mile” of the inflation fight is proving to be the most challenging. Historically, 3% inflation has been fine for the US Economy. But there’s a compounding effect from the much higher rates. It’s also important to understand that though the rate of increase has slowed, prices are over 20% above the pre-Covid levels.
The Market was pricing in 6-7 rate cuts at the start of the year. No more. It’s now pricing in 2, if that. June rate cut odds fell to 27%. It was 60% earlier in the week and a near 100% probability back in January. The Market always moves. And there’s this from Chair Powell, the head of the Fed: “We’re in a situation where if we ease too much or too soon, we could see inflation come back, and if we ease too late, we could do unnecessary harm to employment.” Yep, the Fed is stuck.
The good news is the American Economy continues to prove its resilience and strength. 300K jobs were created last month. That was well ahead of expectations. Consumers are out and about, and they keep spending. I’ve seen it at airports and hotels across the country the last few weeks. America’s economic engine is humming. Because of this, the central bank doesn’t feel intense pressure to cut rates. However, policymakers also don’t want to risk falling behind the curve again. That they did at the beginning of the latest cycle and may have to act earlier than expected to pull off a so-called “soft landing.”
Another issue the Market is finally starting to pay attention to: Deficits keep going higher. The US budget deficit widened to $1.07 Trillion in the first half of the fiscal year. Government spending is ignoring all of this. This week’s Treasury auction reflected that. Yields spiked. The $39 Billion 10-Year auction was the latest to come in weaker than expected. The auction tailed by 3 basis points (0.03%). That might seem small, but in Bond Land, it’s material. It was the worst since December of 2022. It was the third largest on record. Now you see the significance. Demand was so low that the Bond dealers had to take 24% of the auction. That’s the highest in 2 years. Bond dealers usually take half of that. This is a clear sign there is shrinking demand for longer-dated Treasuries. Conversely, demand for shorter-term Treasuries remains solid.
There’s also this: Credit card delinquency rates reached their highest level on record to close out 2023. That, according to the Federal Reserve Bank of Philadelphia. “Firms recording the worst 30+, 60+, and 90+ account-based days past due levels,” the report said, warning that stress among cardholders was underscored in payment behavior and further performance deterioration could be on the horizon. In addition, mortgage originations declined to a series low as housing affordability has cooled demand.
As Earnings Season begins again, we’re always looking for clues about demand growth. Something way below the radar perhaps is this: The Frozen Potato Indicator. Lamb Weston is the largest producer of frozen potatoes to fast food restaurants. The Idaho company is seeing a decline in demand. French fries are the most-consumed item in fast food. But few people order fries on their own. That’s why the catchphrase, “You want fries with that?” has been so impactful for the industry. Watching demand for fries can be a good measure for gauging the economic health of the American Consumer. I suppose it could be used to measure the physical health as well…
Amazon has also sensed a bit of a slowdown. Amazon CEO Andy Jassy said that customers keep buying, but the company has noticed that they’re being “more careful” in how much they spend. Amazon has access to tons of data reflecting the American Consumer. It also can use that precious data for its Artificial Intelligence innovations. Of course it’s been AI which has been the biggest Stock Market driver. But even that has stalled a bit. We will learn a whole lot more when the Tech Titans report earnings in a few weeks.
JP Morgan is the largest financial institution in America. Its CEO, Jamie Dimon, is always worth listening to. He rarely minces words and increasingly says whatever he feels without filter. It’s actually quite refreshing. In his annual letter to shareholders released this week, Dimon wrote: “These markets seem to be pricing in at a 70% to 80% chance of a soft landing – modest growth along with declining inflation and interest rates. I believe the odds are a lot lower than that.” Dimon also highlighted the “huge fiscal spending, the Trillions needed each year for the green economy, the remilitarization of the world, and the restructuring of global trade” as contributors to inflation. “Therefore, we are prepared for a very broad range of interest rates, from 2% to 8% or even more, with equally wide-ranging economic outcomes.” Very few people are expecting 8% interest rates. Even fewer are prepared for them.
Back to the Market:
Things didn’t get less complicated this week. Inflation is proving sticky and stubborn. The Banks mapped out a murky environment ahead. Things are getting increasingly worse in the Middle East. And there’s also that consequential election in November with an outcome that’s anyone’s guess at this stage.
Israel is reportedly preparing for a direct attack from Iran as soon as this weekend. Although Iran signaled it would send a limited response in a bid to avoid major escalation. The US is pressing global leaders to caution Iran from significant retaliation. Both Oil and Gold have been soaring, which reflects the current angst within the Market. Silver and Copper too. A geopolitical premium has triggered the rising price of those real assets.
It was a strong start to the year for the Stock Market. But the rally has also stalled with the Dow and S&P spinning sideways for the last few weeks. Keep those belts buckled. We’ve reached those bumps in the road. It might take a bit before things smooth out.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
