Anecdotal evidence supports inflation’s continued slide. Data is typically more reliable than anecdotes, but it is different in this instance.
Before there is data, there are anecdotes. Some anecdotes should be dismissed because they are erroneously told memories or opinions of reality. The benefit of data is that outliers are smoothed out by aggregating many stories (AKA data points). But there are anecdotes, and there are anecdotes.
Some of the highest-quality first-person viewpoints are found in the Federal Reserve’s Summary of Commentary on Current Economic Conditions. The 56-page summary, more commonly known as the “Beige Book,” is published eight times yearly, most recently on May 29, 2024. Each Federal Reserve Bank gathers anecdotal information on current economic conditions in its district through reports from bank and branch directors and interviews with key business contacts, economists, market experts, and other sources.
The most recent “Beige Book” shows that consumers are resisting price increases, and businesses have had to offer discounts to attract them. Target, Walmart, Walgreens, and Amazon have cut prices on thousands of items. McDonald’s, Burger King, and Wendy’s have announced new value meals. Tesla has cut prices globally amid slowing demand.
The Federal Reserve’s next meeting to determine its interest rate policy is June 12, 2024. The Fed is not likely to cut rates then, or even at the next meeting, as it allows this process to unfold and (hopefully) sees inflation track lower to its target rate of two percent.
On Friday, May 31, the Bureau of Economic Analysis released its inflation data for April. The BEA’s metric for inflation is the Personal Consumption Expenditures Price Index (PCE). The PCE is the Federal Reserve’s preferred inflation gauge. More specifically, the Fed watches the core PCE, which strips out more volatile components such as food and energy.
The PCE data for April was relatively good. As you will recall, the first few months of 2024 were a worrying start for the year. Inflation was coming in hotter than expected. There was even some talk of a rate hike instead of a rate cut, which dropped the S&P 500 by about five percent.
April’s data should put to bed the fears that an inflation acceleration is underway. The year-over-year numbers for PCE and core PCE came in as expected, at 2.7 percent and 2.8 percent, respectively. While we are not yet at the Fed’s two percent target, we also don’t seem to be heading back to its multi-year highs or even to the mid-threes, allowing the Fed to keep rates high for longer.
Many investors agree that an interest rate cut will spark a stock market rally. However, investors should be careful of what they wish for. A rate cut isn’t “free”; it will come at a cost, and that cost is why the Fed allows rates to lower.
If the Fed cuts rates because consumers won’t pay higher prices, that also means businesses have lost pricing power. Those companies will suffer lower profit margins. There is some nuance there: Diminished pricing power will squeeze profit margins, but that doesn’t necessarily cease earnings growth.
Wall Street analysts will almost certainly reduce earnings estimates of publicly traded companies for the current and next quarter. Considering the negative change to earnings estimates as a whole and profit margins specifically, an astute investor might wonder why many U.S. stock market indices are trading near all-time highs. Investors are convinced that companies will experience many years of improving earnings. The anecdotes from the most recent Beige Book support the expectation of continued economic strength, thus supporting the optimistic view on long-term earnings growth.
On May 30, the Bureau of Economic Analysis released its second estimate of U.S. Gross Domestic Product (GDP) for the first quarter 2024. GDP is the value of goods and services bought by consumers. GDP growth came in at 1.3 percent. That is a soft number compared to the average for the previous four quarters, which came in at 3.15 percent.
The Atlanta Fed GDPNow tool tracks GDP at 2.7 percent for the current quarter. While that is the most popular nowcasting tool, I find Moody’s to be more accurate, and they are tracking current GDP at 2.0 percent. Either way, that pace of economic growth is a tailwind for higher corporate earnings.
For investors making stock market bets based on when—or if—the Federal Reserve will cut rates, the economy’s strength is of the utmost importance. As suggested earlier, the consensus belief is that the stock market will roar ahead when the Fed begins to lower the cost of capital. A post-rate-cut stock rally is possible, but it is conditional.
Investors desire rate cuts, but they should delineate that they want them because inflation is under control and not because the economy needs a boost. Investors want the economy to weaken enough from its healthy pace to curtail rising prices but not weaken in any material way. A 2.0 percent GDP growth rate this quarter could be better for the stock market than a 2.7 percent rate.
I am concerned that is asking for too much. Consider pending home sales. The National Association of Realtors created the Pending Home Sales Index, which tracks home sales where a contract is signed but the transaction has not yet closed. It got shellacked in April 2024. Pending home sales declined 7.7 percent, with all regions in the U.S. registering decreases month over month and year over year.
The Pending Home Sales Index is now at 72.3, a record low. The index generally leads existing home sales by a month or two. The good news is that reduced demand should help bring costs down (total housing inventory is up 16.3 percent from a year ago). However, the bad news is that this is not how we want to achieve a lower inflation rate; declining home sales would be a headwind to stock prices.
Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com. Adviser is not licensed to provide and does not provide legal, tax, or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.
