Poking holes in our own analysis … the case for a continuation of disinflation … a deeper dive into Wednesday’s CPI report … why Luke Lango is busy during this “buying season”
Let’s begin today by poking holes in our own recent analysis.
The Digests on Wednesday and Thursday leaned bearish in the wake of the hotter-than-expected Consumer Price Index (CPI) report.
In our analysis, we looked how progress on inflation has been stalling. We also highlighted the toxic combination of the surging 10-year Treasury yield, the strengthening dollar, and climbing oil prices.
The quick takeaway was that these factors are creating a headwind for stock market gains, and a significant correction is a real possibility.
Today, let’s look at this from the opposite angle.
One of the worst things investors can do is become married to their own narrative. This creates blind-spots that, all too often, result in portfolio-damaging decisions.
So, what’s the bullish perspective on this week’s economic data and the recent wobbles in the stock market?
Is inflation really rearing its head again or not?
To help us with today’s analysis, we’re turning to our hypergrowth expert Luke Lango. To be clear, Luke isn’t a “perma-bull;” rather, he’s bullish because of what he’s seeing in the data.
Let’s begin with his overall take on inflation and the growing fear that it is heating back up. From Luke’s Daily Notes in Innovation Investor:
We maintain that inflation is going to push lower over the next few months.
The current bout of reinflation isn’t supply-driven like the inflation boom of 2022. This bout of reinflation is demand-driven.
It started in late 2023 when the Fed executed a huge dovish pivot on policy. Yields crashed. At the same time, everyone stopped talking about a recession. Consumer sentiment soared.
And that combination of crashing yields and rising consumer sentiment led to broadly strengthening economic demand, which pushed inflation higher.
This is demand-driven reinflation. Not supply-driven.
Luke points toward the higher 10-year Treasury yield and the growing fears of a “hard landing,” both of which he says will weaken consumer sentiment, and by extension, demand, as we move forward.
Here’s his takeaway:
Therefore, over the next few months, we see the demand dynamics which created reinflation in February and March, sharply turning course in the other direction.
As a result, we maintain our outlook for inflation to fall over the next few months.
Meanwhile, was Wednesday’s CPI report really as bad as it seemed?
If you missed it, on Wednesday, the Consumer Price Index came in above estimates for the third consecutive month. As we noted here in the Digest, this paints the picture of progress on inflation stalling out.
But are we wrong? Was the CPI not quite as bad as it seemed?
Here’s Luke:
When you look at the components of inflation, the report becomes a lot less scary.
Food inflation is running at 2.2% and falling – so that’s normal and falling. Commodity inflation ex energy is running at -0.7% and falling – so below-normal and falling. Medical care inflation is running at 2.1%. Education and communication services inflation is running at 1.4%.
Pretty much all components of inflation are running around normal levels and falling, except for shelter and energy.
Shelter inflation is high at 5.6%. Energy inflation is rising.
But, while shelter inflation is high, it is falling pretty steadily and should keep falling. And, while energy inflation is rising, it’s currently running at just 2.1%, which is low.
In other words, when you actually look at the components of inflation, there isn’t anything all that worrisome.
The research shop Morningstar echoes Luke’s take on shelter inflation.
It explains that because most people aren’t signing new apartment leases and/or buying homes frequently, it takes time for changes in shelter costs to show up in the various price indexes. So, current CPI inflation is still running high due in part to the run-up in rents and home prices since 2021.
Here’s Morningstar with why it anticipates cooler shelter prices in the coming quarters:
Market rents are now decelerating sharply in response to falling housing demand and expanding apartment supply. Rent growth fell to only about 1.7% year over year as of December 2023, from its peak of 15.7% in February 2023…
We expect home prices to fall as weak home demand will continue to weigh on housing prices… his will return the CPI shelter index to normal…
Lower housing prices will also aid in returning housing affordability to more reasonable levels. From a cost perspective, lower home prices should become more palatable for builders as easing supply constraints reduce the cost of construction inputs.
But what about that surging 10-year Treasury yield?
Even if we can explain away the uptick in inflation, the soaring 10-year Treasury yield is a problem for many stock valuations as well as interest-rate sensitive assets.
Yesterday, the yield hit 4.59%, which is the highest level since last November when the S&P traded almost 15% lower.
While Luke is objective about the risk to stocks posed by a yield that keeps climbing, that’s not what he envisions happening:
If yields keep rising, stocks will struggle. But we don’t think yields will rise much further.
There’s a lot of technical resistance on the 10-year between here and 5%. It will take a lot of selling pressure to keep pushing yields higher from here. We don’t think that selling pressure will arrive.
The 10-year Treasury yield is about 100 basis points above the CPI inflation rate. That’s a huge gap. We don’t think yields have much more upside “juice” after bursting through 4.5%.
So far, all of this has been “defensive” – is there anything “offensive” that could give stocks a boost?
How about earnings?
As we highlighted in yesterday’s Digest, earnings season begins in earnest today with reports from JPMorgan, Wells Fargo, and Citigroup. Luke believes the results will be strong enough to buoy stocks:
To be sure, worries about reinflation will likely remain front-and-center until the next round of inflation reports in May. But, until then, the market should be able to grind higher on the back of strong corporate earnings.
[Q1] profit estimates are rising nicely into earnings season, with analysts meaningfully revising their earnings estimates. Typically, that’s a good sign that earnings should be strong this quarter.
To Luke’s point, FactSet, which is the go-to earnings data analytics group used by the pros, reports the earnings growth rate for the S&P for this Q1 earnings season is 3.2%.
Here’s FactSet with the sector breakdown, as well as earnings growth forecasts for later this year:
Seven of the eleven sectors are projected to report year-over-year earnings growth, led by the Utilities, Information Technology, Communication Services, and Consumer Discretionary sectors.
On the other hand, four sectors are predicted to report a year-over-year decline in earnings, led by the Energy and Materials sectors…
Looking ahead, analysts expect (year-over-year) earnings growth rates of 9.4%, 8.5%, and 17.5% for Q2 2024, Q3 2024, and Q4 2024, respectively.
For CY 2024, analysts are calling for (year-over-year) earnings growth of 10.9%.
So, how do we resolve the bearish leaning of the Digests earlier in the week with Luke’s bullish take?
First, we resist the temptation to generalize. What happens in “the market” – whether bullish or bearish – could have little or zero effect on the specific stocks in your portfolio.
While it’s important to be aware of what the major indexes are doing (which reflects broad consumer sentiment), your wealth will rise or fall based on the specifics of your unique holdings, not, say, the S&P.
So, continue riding your stocks higher as long as they’re climbing. If one hits a stop-loss, be disciplined, and sell to protect your capital. But barring that, stick with the trend, which remains bullish even after this week’s wobbles.
Here’s Luke’s bottom line from Innovation Investor to take us out today:
Overall, we are maintaining our bullish outlook even in the face of [Wednesday’s] hotter-than-expected inflation print and subsequent stock market crash.
That’s because we think:
1) Earnings over the next few weeks will be strong enough to stem the market’s decline and push stocks higher,
2) Inflation will resume its decline in the May round of inflation reports amidst higher yields and lower economic demand, and
3) The Fed will still cut rates multiple times between the summer of 2024 and the end of the year.
Our strategy remains to be strategically aggressive during this turbulent time. Given recent trends, we are adjusting the specifics of that aggression to lean more towards high-growth stocks and lean away from rate-sensitive stocks.
But that’s just a short-term development. Over the next 12 months, we believe both high-growth and rate-sensitive stocks will soar.
We’re staying bullish. We’re staying in the game. We’re continuing to take shots.
Have a good evening,
Jeff Remsburg
