A good place

Finally, thanks to the midweek inflation report, we had some signs of animal spirits return to the market. With risk back on, we can stress about valuations, as the equity risk premium for the S&P 500 versus the 10-year Treasury stands at -68 basis points. Bonds a better buy than stocks?  Strategas notes it’s not necessarily bad since the period 1980-2000 (a great bull market, averaging 17.8% annual equity returns) saw equity risk premiums ranging from 0 to -400. Market breadth remains weak even if there are signs of improvement, with the CPI data on Wednesday prompting 83% of the names in the Russell 3000 to advance. That was the best breadth showing in half a year and the roughly five to one ratio of advancers to decliners might indicate the quasi-correction is behind us and the uptrend can resume. Nonetheless, we’ve gone six months without the market showing at least half of stocks at 20-day highs, so there’s still work to do if the rally is to have legs. One point in the market’s favor right now is that sentiment, a contrary indicator, is down. The bull/bear ratio is roughly even against 3.5 to 1 in recent weeks. Yields fell enough this week to give equities a fair chance at good returns going forward. American equity exceptionalism continues to be evidenced in a stock market capitalization that is growing faster than the rest of the world. No wonder, the US is enjoying higher rates of growth in both earnings and GDP.  

Inflation readings moderated this week, reversing the sour mood with which January began. Headline inflation was still high, but that was due to energy prices; core readings were better than expected. What’s kept inflation from coming all the way back to 2%? Government spending is a prime suspect. Last year Uncle Sam’s expenditures rose more than 10% y/y, making 2024 the first time in more than 50 years that this has happened outside of a recession. While we cheer inflation’s retreat, not all participants experience it equally. Strategas offers a “Common Man” measure that looks at the essentials of life, namely, food, energy, shelter, utilities and clothing. That measure is up 20.8% over the past four years versus a 16.1% increase in wages. This may help explain why President Biden received so little credit for low unemployment and falling inflation. Discretionary items are getting more affordable even as the cost of “common man” necessities are rising. As noted, energy was the main outlier in the benign inflation report, with oil futures up 10% during a normally slow time of year. The incoming Trump administration’s policies are a wild card here, with regard to tariffs and also the sanctions on Russian and Iranian oil. As US disinflation has stalled, global inflation is running just below 2% on a headline basis and just over 2% core, nearly back to pre-Covid levels.  

A growing economy with inflation under control is historically bullish. For now, 2025 looks like a midcycle steady-as-she-goes year, as the expansion continues at a measured pace. The labor market is well balanced, GDP growth is solid, consumers are in good shape and the wealth effect is on the job. The Atlanta Fed’s GDPNow tracker has Q4 GDP growth at a very healthy 3%. Absent a resurgence in inflation, that sort of growth should continue. The New York Fed says the probability of recession in the next 12 months is 29%. (Good odds, although the probability hit 12% the month before the Great Recession began.) The last time the Fed pulled off a soft landing was in the mid-1990s.  At that time, long-term rates rose when then-Fed Chair Alan Greenspan quit cutting rates and the growth oulook picked up. Fears of price hikes remained, but Greenspan was convinced that rising productivity would keep both unemployment and inflation low. The Fed has two objectives when it sets monetary policy—stable prices and maximum employment. Check and check. It has indeed been a soft landing … to a good place.

Positives

• In a good place Core CPI rose just 0.2% m/m against expectations of 0.3%. Core CPI minus owner’s equivalent rent came in negative y/y. Higher energy costs drove the headline number up 0.4% m/m. The CPI numbers came the day after producer prices were reported flat on a core basis for December. Benign comparables the next few months may help further. While this week’s numbers may not hasten the next rate cut, they restore a sense that inflation is not reigniting.   
• Business owners are pumped The NFIB’s small business optimism index rose to its highest level in six years in December, with forward economic expectations up to levels not seen since March 2002. A report like this is a good omen for the health of the consumer going forward.
• Signs of an upturn The National Association of Home Builders index rose to its highest level in nine months, and housing starts rose more than expected, with particular strength in multifamily. Also, industrial production gained 0.9% in December, thanks in part to the end of Boeing’s strike. Finally, the Philadelphia Fed Manufacturing Index jumped to pre-Covid levels, though this may partly reflect pre-tariff planning.

Negatives

• A restrained (but not silent) cash register Retail sales rose a nominal 0.4% in December versus expectations of 0.6%. The “control group” of stores, however, beat expectations, rising 0.7% against 0.4% consensus. Gains were widespread in the retail space, and inventories remained low.
• Not much is in motion Shipments in the Cass Freight Index fell 7.3% m/m in December, and now three of the past four months have been down. Some of the recent weakness is due to weather, but shipments are down 6.5% from a year ago.
• New York blues The New York Fed’s Empire Manufacturing Index fell to -12.6 in January from December’s 2.1. New orders and shipments were down and the work week sank. Still, respondents’ outlook increased to a cycle high and capital spending intentions rose to their highest level since the spring of 2023.

What Else

Will I lose my job to AI?! A new Citibank survey found that 54% of CIOs think AI will reduce headcount. Of these, 48% foresee a reduction of 4-9% with 30% expecting payrolls to shrink by 10-15%. Of note, 81% of CIOs think this will be happening in the next year or two!

Climate change to blame? Last year, the US had 27 disasters that cost $1 billion or more, totaling $182.7 billion. Compare this to 2010-19, during which we had just 13 such disasters a year at an average total bill of $99.6 billion. Back in 1980-89, we averaged just three of them, costing an average $22.0 billion per year.

Too much is no more A pandemic-era inventory glut now seems at or near the end. How to know? Company calls’ mentions of “destocking” are back at pre-Covid levels. Maybe this means the stagnation we’ve seen in manufacturing can come to an end, bringing a soft part of the economy back to life.