The consumer price index for April printed bang in line with expectations, and now rate-cutting looks within sight. Or so the market believes.
The headline -- "all items" -- CPI rose 4.9%. That was the first time the number fell below 5% in 24 months. That slight 0.1% miss, plus the markdown in services inflation -- which has been the stickiest part of the index -- is what got the market excited. The report ostensibly means the Fed may be close to cutting rates. But that is rather twisted logic, because if one looks at the core CPI not including food and shelter, it came in at up 5.2% year-over-year. Inflation is still very sticky and miles away from the Fed's 2% target.
Hence, the market's rejoicing is a bit premature.
It is with this belief and faith in the Fed pivot, that investor money is flowing into the large-cap technology space, as they will be the ultimate beneficiaries of the eventual rate cut that may be needed, once the Fed realizes that the economy has slowed down much more than hoped for. But we are not there yet. Jobless claims may be picking up, but the labor market is far from showing slack. In fact, Fed Chair Jerome Powell and other members are patting themselves on the back as though they seemed to have defied all economic models altogether by getting inflation down, but employment is sticky. There is usually a time lag, but when numbers do show up, it means things are already much worse.
Some may point out that the S&P 500 has been stuck in a boring trading range from 4000 to 4150 over the past month. And, looking back further, it really has not moved since last June, bar a slight break to the downside in October and one to the upside earlier this year. Looking just at the index level, one would be fooled by its strength. Outside of a handful of the large-cap technology names like Apple (AAPL) , Amazon (AMZN) , Alphabet (GOOGL) , and Microsoft (MSFT) , the breadth is quite horrible with some names back down to lows if not lower.
After the volatile early spring with the crisis in U.S. regional banks, the market has rallied back up as contagion seems limited, especially to the big banks and banks abroad. The issue is not about U.S. regional banks, where it seems the managers mismanaged their assets and liabilities, despite the Fed's warning to tackle inflation. To an extent some may be allowed to be eaten up by their bigger brethren, but the bigger issue is that these smaller regional banks were responsible for most of the commercial real estate, and risky venture loans out to various parts of the economy. Now, along with the big banks, they will have their hands tied on lending. This was evident in the recent bank and lending survey that showed how banks were tightening their standards to levels not seen since 2008. It is the opposite of what we had been seeing all throughout the last decade as rates were close to 0% and money supply was at its height.
Back the the Fed.
The economy has yet to feel the full impact of the 5 percentage-point rate increase. Just like a big boat being steered, the captain best not turn it too much, as there is a time lag between the rudder and the boat's direction. Services inflation may be coming down, or at least trending in the right direction, but this along with food inflation is holding at elevated levels. We know companies are not eager to pass through lower costs just yet, as they will try to keep their margins up as much as possible at the cost of the consumer, as some are still passing through the costs from the second half of last year.
Investors are parking their cash in a handful of names; concentration is the highest it has ever been, which is never a good thing. Money market funds may be yielding 4.5%-5% but those are considered risk free. Investing in large-cap technology because it has $100 billion cash flow, does not guarantee stocks cannot fall as they are still equities after all, not risk-free T-bills.
Investors have gotten so used to the Fed always saving the day or buying the dip, that they chose to ignore what is developing in other parts of the cyclical economy as producer prices are collapsing. Earnings estimates are priced for a brisk recovery in the second-half of 2023, which seem blatantly optimistic. All hope rests on China's revival, but China cannot alone save the world. It too has its own issues to deal with, all 1.4 billion of them.