Broker Check

Further Skepticism About Inflation and The Federal Reserve’s Resolve

| April 15, 2024

Since March 15, equities basically have been rangebound (i.e., consolidation). There was a similar 25-day consolidation period recently from mid-December to mid-January, which was then followed by a 12% rally into March.

We at Cornerstone Financial Services viewed last week’s March consumer price index report as a potential catalyst for the short-term direction of the markets following the recent consolidation. Going into the report, we felt probabilities favored a cooler CPI figure. Unfortunately, that was not the case.

Last week we said anything below 0.3% on core CPI would be a positive development, while anything above would be unexpectedly hot. March’s core CPI accelerated 0.4% monthly, increasing the year-over-year figure to 3.8%:

The market immediately responded negatively while yields rose. We’d attribute the initial market reaction to further skepticism about cooling inflation and the Federal Reserve’s resolve to cut interest rates anytime soon. Stocks gained in the trading session that followed, though fell to end the week, so time will tell the longer-term effect of this inflation news.

The biggest contributor to core CPI rising was continued increases in shelter costs, which jumped 0.4% for the month and 5.7% on a year-over-year basis and is the main reason for the currently sticky inflation. Shelter accounts for roughly a third of the overall weighting.

One silver lining was used vehicle prices declined again, this time by 1.1%. That should translate to decreases in auto insurance prices later this year.  This is a positive development as the other main driver of last weeks CPI report was auto insurance.  As vehicle prices subside that will lead to auto insurance decreasing in the future as well.

Additional inflation concerns revolve around oil. Brent crude recently hit a price of $85 per barrel, which is a multi-month high, due to supply cuts and volatile geopolitics.

Furthermore, stocks were hurt by the 10-year Treasury yield, which jumped to nearly 4.5%:

The 10-year yield increase was a direct response to the shift in Fed rate cut expectations. Markets are now betting on the first cut being in September as opposed to June:

These data points and the popular adage of “sell in May and go away,” require us to keep paying close attention to day-to-day data and remain nimble in our approach. The long awaited short-term correction we mentioned earlier in the year could come to fruition.

The Strength of Energy

With this new data, we must closely monitor what truly moves markets – buying and selling from “big money” professional investors. The data for the last few months has shown MAPsignals’ trusty Big Money Index (BMI), a 25-day moving average of “big money” investor netted buys and sells, to be sideways after falling from overbought territory in February:

Clearly the market remained strong during that time. However, we fully expect last week’s inflation news and resulting volatility to rattle nerves, even though there’s been no visible increase in unusual selling over the past few weeks of market consolidation:

With persistent inflation and investor uneasiness playing seemingly larger roles in market performance, we’ll need to remain even more vigilant than usual in eyeing the data for any outsized outflows in the upcoming weeks.

Understanding the potential risk in the short term, let’s now turn to sector performance. There’s been a change in leadership as energy took the top spot in the MAPsignals sector rankings over the last few weeks in potential anticipation of inflation risk:

This table reflects the strength of energy buying recently. Not coincidentally, in our most recent portfolio rebalance on April 1, we either maintained or increased our weighting in energy assets as a hedge against the risks that are now playing out.

  • There are four primary reasons for maintaining or adding energy exposure to our portfolios in the second quarter:As mentioned, energy rose to the top in our sector data. That move reflects a broadening of the market overall, which is great for value-minded investors. Also, we viewed adding energy positions as a hedge to the exact sort of inflation print that occurred last week.
  • Speaking of value, energy stocks were outright cheap at the end of March. The S&P 500* has a forward-looking price to earnings ratio of 20.81 while the energy sector’s forward P/E is 12.87:

  • Energy stocks continue to pay handsome dividends, returning cash to shareholders at a record pace. History has shown that over 40% of the market’s long-term returns are due to dividends. As our clients know, we believe investing without the benefit of dividend payments is a foolish proposition. On average, energy stocks offer a 3.32% yield, which is 150% higher than the S&P 500’s dividend yield of 1.32%:

  • During periods of market volatility and consolidation, dividend stocks (like energy stocks) offer a solid alternative for income needs that allow you to maintain equity exposure while also getting paid to wait out the storms.

Thus, as we were analyzing our portfolio positions going into the second quarter, energy’s leadership made a lot of sense tactically and from a macroeconomic perspective. This is especially true since we wanted to hedge against the potential for a market pullback if any negative catalysts appeared…like a hot CPI print.

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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.