This Bull Market Is Still Young
As we’ve been saying for close to 18 months, we think we are in a new bull market and the economy will avoid a recession over the coming year. Not much has changed, and we still feel this way. Yes, there will be pullbacks, corrections, and scary headlines along the way, but overall, plenty of positive territory remains.
- Stocks gained for the second week in a row, as strong earnings, a dovish Fed, and a “Goldilocks” job number sparked buying.
- The current bull market is young, and additional returns remain likely.
- The Fed is watching inflation carefully but considers rates restrictive enough. A rate cut this year remains much more likely than a hike.
- The April jobs number showed a healthy job market while easing concerns that the economy is overheating.
The current bull market is up 43% and less than 19 months old. Should this bull market end now, it would be the shortest and smallest bull market ever. In other words, the odds favor continued market strength.
The average bull market lasts more than five years and gains 167% on average (with a median of more than 107%). So, it is likely that markets will continue to focus on the economic resilience and business resourcefulness that have been clearly demonstrated.
Powell and Fed Members Keep Their Eyes on the Big Picture
The takeaway from the Federal Open Market Committee (FOMC) meeting is that inflation has eased considerably since last year but remains elevated. As a result, the Fed is maintaining policy rates where they are (in the 5.25-5.50% range). At the same time, Federal Reserve Chair Jerome Powell believes the disinflation process will continue, and so the next major move Fed members make will likely be to cut rates. However, that’s not going to happen until they gain “greater confidence” (in their own words) that inflation is headed back to their 2% target.
There’s no question that inflation ran hot in the first quarter, especially relative to the second half of 2023. From the chart below, it appears inflation progress has stalled, with the Fed’s preferred inflation metric, the Personal Consumption Expenditures Index (PCE), running at 2.5-3% since December. Core inflation, which strips out volatile food and energy components, has been going the wrong way. Over the last six months, core PCE has run at an annualized pace of 3.0%, and over the last three months it has been up to 4.4%.
It would be easy to view the data in the chart above and deduce that the inflation progress from the second half of 2023 has reversed. However, Powell and the Fed did not say this. Instead, they emphasized that inflation has eased significantly over the past year (six-month core PCE was running around 4.5% a year ago). However, it’s clear that inflation remains elevated relative to their 2% target. Hence the need to keep rates where they are.
The hot first-quarter inflation data also raised concerns about the dreaded stagflation scenario. However, Powell pushed back hard on this in his post-meeting press conference, noting that stagflation is when unemployment is high (around 10%) and inflation is in the high single digits. That’s not the situation now. The unemployment rate has been below 4% for 26 straight months, and headline PCE inflation has been in the range of 2.5-3%.
In fact, Powell added that the Fed expects inflation to continue to ease, mostly for two reasons:
- More supply-side improvements: This was behind the historic inflation drop in 2023, and the Fed believes more supply-related relief lies ahead.
- Policy rates: Policy rates are restrictive, but they need time to play out.
This is why Powell said the next move will likely be a rate cut, rather than a rate increase. The hurdle for a rate hike at this point is fairly high. However, considering the first-quarter inflation data, it will take longer for the Fed to gain confidence that inflation is headed back to their 2% target, and the Fed would need that confidence to start cutting interest rates. The inflation data in January and February did not suggest inflation is headed higher. A lot of the so-called “heat” and “persistence” was due to idiosyncratic factors, such as housing inflation and auto insurance.
The overall inflation numbers, including for core inflation, can hide what’s happening beneath the surface. To illustrate this, we reviewed all 178 categories within core PCE inflation and calculated the distribution of year-over-year inflation over different periods. It’s clear how inflation broadened out in June 2022 relative to December 2019. Encouragingly, the distribution is narrowing once again. The picture for March 2024 looks closer to what it did in December 2019, rather than June 2022.
As the chart shows:
- In December 2019, just 10% of categories had inflation rates above 4% year over year.
- In June 2022, 58% of categories had inflation rates above 4%.
- In March 2024, 36% of categories had inflation rates above 4%.
This gets back to the big picture:
- We’ve made considerable progress on inflation over the last two years.
- Inflation remains elevated.
In fact, we even made progress on inflation in the first quarter. In December 2023, 42% of categories had inflation rates above 4%, versus 36% of categories in March. More progress would have been ideal, but the trend was moving in the right direction, which explains why the Fed is not panicking. Neither are we. It helps to focus on the big picture and the ultimate objective, which is not bad advice in investing.
Of course, this means interest rates are likely to stay close to their peak rate for this cycle (5.25-5.50%) for a tad longer. But continued progress on inflation means we could see one or two rate cuts in 2024, perhaps in September or December. Of course, this means the next few inflation reports take on outsized importance.
The April Employment Report Suggests the Economy Is Strong, But Not Red Hot
The April employment report was the first one in months that went well against market expectations. Three blockbuster payroll reports in the first quarter had conditioned sentiment toward expecting more of the same, but instead we got something more lackluster. Payrolls grew 175,000 in April — below expectations of 240,000 and lower than the red-hot Q1 monthly average of 269,000. This shifts the narrative from a no-landing scenario to soft landing, i.e., a steady economy with inflation falling, which would allow the Federal Reserve to cut interest rates.
Perhaps the best evidence is aggregate income growth across all workers in the economy. Ultimately, income growth drives consumption, and aggregate income growth is the sum of employment growth, wage growth, and the change in hours worked. Over the last three months (through April), overall income growth has grown at an annualized pace of 5.9%. That’s strong and above the pre-pandemic pace of 4.7%, but it’s far from red hot.
In short, nothing in the employment data suggests an overheating economy that will keep inflation high and push the Fed to maintain policy rates as high as they are now (5.25-5.50%). If nothing else, this report makes the prospect of further rate increases even more unlikely, underlying what Powell said earlier this week, which the market cheered.
Make No Mistake, This Economy Is Good for Stocks
Aggregate incomes running close to a 6% annual pace suggests nominal GDP is also running at 5-6%. That environment is good for profit growth, which in turn is positive for stocks.
While payrolls came in well below expectations, 175,000 is above the 2019 monthly average of 166,000. Analyzing monthly job numbers requires caution because they can be revised. But over the last three months, payroll growth has averaged 242,000. The corresponding number exactly a year ago was 237,000. In other words, the labor market has remained strong, with not much acceleration or deceleration.
The unemployment rate did tick up from 3.8% to 3.9%, but April is the 27th month in a row in which the unemployment rate has clocked in below 4%. That’s the longest streak since the 1960s. As mentioned previously, the prime-age (25-54 years) employment-population ratio gets around definitional issues that crop up with the unemployment rate (a person is counted as being unemployed only if they’re “actively looking for a job”) or demographics (an aging population with more people retiring and leaving the labor force every day). The prime-age employment population ratio rose in April to 80.8% — that’s only slightly below the high from last summer and above anything between 2001 and 2019, when it peaked at 80.4%. In fact, the prime-age employment population ratio for women just hit an all-time high of 75.5%. This by itself suggests the labor market is strong, as more people are participating in it.
A Strong Labor Market Is Good for Productivity Growth
A theme of our 2024 Outlook is a possible resurgence in productivity growth. Over the last year, productivity grew 2.9%. That is well above the 1.1% annualized pace between the first quarter of 2020 and the first quarter of 2023, or the 1.5% annual pace between 2005 and 2019.
A strong labor market incentivizes businesses to invest more, which is a key ingredient for productivity growth. Importantly, when productivity increases workers can see strong wage growth without necessarily pushing up inflation. Falling inflationary pressures can allow the Fed to ease interest rates. Even if rates are shifted lower by a relatively small degree, that can further boost investment and keep the productivity growth engine running. This is something that occurred in the mid-to-late 1990s. A similar situation bodes well for the economy and stocks.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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