WEEKLY E-MAIL

18 March 2024

US INFLATION TO KEEP RATES ON HOLD AS THE MARKET PUSHES NEW ALL-TIME HIGHS

By Amelia Paullo

On Tuesday 12th of March the US Labor Department reported that the Consumer Price Index (CPI) rose 3.2% year-on-year in February, up from 3.1% in January and slightly above the mark that most economists expected. This is still much higher than the Fed’s target inflation rate of 2.0%. On a monthly basis, the CPI gained 0.4%. The latest CPI numbers come following stronger than expected labour market figures, which reported that the US economy added 275,000 jobs in February, beating expectations of 198,000 jobs.

The Fed has raised interest rates 11 times since March 2022 in an effort to rein in surging inflation, which peaked at a 40-year high of 9.1% in June 2022. Their target range is now 5.25%-5.50%, which is the highest in 22 years.

Not only is the Fed’s high target interest rate range putting pressure on the economy to slow down, but it also allowing $60 billion in government bonds and $35 billion in agency mortgage-backed securities that mature every month to roll off its $7.5 trillion dollar balance sheet. By not purchasing more of these securities the Fed is conducting a form of quantitative tightening and effectively reducing the growth in the broad money supply in the US economy in order to reduce inflation.

Tuesday’s strong CPI report may have the effect of postponing when the first rate cut may take place in the US. Previously, investors were predicting that the first cut would happen around June of this year, but this new data has market participants guessing it may not happen until September.

The Fed usually cuts rates ahead of an impending slowdown in the economy but with the employment numbers coming through so strongly, it would be difficult to justify any cuts yet. Many economists expect the Fed is likely to cut interest rates one or two times this year, as an acknowledgement that inflation has meaningfully decelerated, even if it is not fully back to its 2.0% target. Markets are pricing in nearly an 80% chance of the Fed cutting rates by at least 75 basis points by the end of the year.

The US stock markets positive momentum has carried over from 2023 with the S&P500 up 7.6% year to date and pushing new all-time highs for the first time in two years.

Many stock market bulls see the market rally as a sign that the economy is safe from a hard landing, but critics point out that the bull market has been led by only a handful of mega-cap technology stocks, primarily the magnificent seven (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta Platforms, Tesla). These seven mega-cap stocks returned 107% in 2023, massively outperforming the S&P500’s 24% gain. They argue that tech stock valuations have become bloated and the market too concentrated.

As can be seen from the below chart, despite the concentration of the top 7 NASDAQ100 stocks being higher now at 59.1% vs 56.1% during the height of the ‘dot com bubble’, the average price to earnings rate is high but more reasonable at 32.5 times vs 80.1 times.

Ray Dalio, the billionaire founder of Bridgewater Associates says his simple answer for investors asking if US equities overall or the magnificent seven mega-cap tech stocks are in a bubble is “no”. “Looking at the Mag-7, we are reading Alphabet and Meta as somewhat cheap, and Tesla as somewhat expensive. We’d call the group in aggregate fairly priced.” Regarding Nvidia he said that, “Nvidia’s two-year forward price to earnings ratio is 27 today, reflecting that, even as the market cap has grown about 10 times, earnings have also grown significantly and are expected to continue to grow over the next few years.”

What can we expect next? Many economists expect firms will likely slow the pace of hiring in the coming months and shrink payrolls as indicated in the recent layoff announcements. However, the recent strength in the job market will likely keep the Fed on hold in the coming meetings. The Fed will get its next key inflation reading on 29th of March, when the Bureau of Economic Analysis releases its February core PCE reading. Finally, the Fed will be watching to see if the U.S. labour market remains hot when the Labor Department releases its February jobs report on the 5th of April.

Amelia Paullo
Financial Planner
SMSF Specialist Advisor™
Authorised Representative No. 1243426

If you have any questions or comments, please email me at amelia@gfmwealth.com.au

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