Public Enemy #1 for the U.S. economy remains inflation. The Consumer Price Index (CPI) inflation report for August 2023 will be released on Wednesday, September 13, 2023, at 8:30 a.m.
Through July 2023, year-over-year inflation cooled to 3.2 percent from its 9.1 percent peak in June 2022. While that is good news, so-called “core” inflation remained stubbornly high at 4.7 percent.
I expect the August 2023 number to come in hot, mainly due to increased gasoline prices. According to the Federal Reserve Bank of Cleveland’s CPI Nowcast estimates, the month-over-month increase for headline CPI in August 2023 is expected to be a meaningful 0.79 percent.
That hot number for August is expected to bump up headline year-over-year CPI to about 3.83 percent from 3.2 percent. However, the Core number is expected to nudge down.
Although the path to the Federal Reserve’s 2 percent target destination will be bumpy, we are heading in the right direction. And we can’t get to that target soon enough. According to a report by The Lending Club, as of July 2023, about 61 percent of Americans are living paycheck to paycheck, up from last year’s finding of 59 percent. Almost eight in 10 consumers earning less than $50,000 per year cannot cover future bills until the next paycheck arrives. For Americans earning over $100,000, four in 10 say they are in the same position. Inflation plays a significant role in that.
Some of that paycheck-to-paycheck pain is self-induced and not necessarily unhealthy. For example, contributing to company retirement plans or making accelerated payments to pay down debt can make things feel tight now, but to the benefit of that person later. However, median apartment rent is $1,510, and U.S. households spend about $690 monthly on food. Add in car payments, gasoline, health, and childcare costs, and you can see how paychecks can get spent up quickly.
In response to higher inflation, the Federal Reserve started an interest-rate-hiking campaign on March 15, 2022. Although higher interest rates are a headwind for the stock market, the Federal Reserve has fortunately been committed to the bigger picture. Sometimes, though, the Fed’s tools seem contradictory to what we want for ourselves. For example, each of us wants a higher income. It would be great if you and I got a raise. However, a raise for everyone would further chase prices higher. In response, workers would demand even higher wages to pay for more expensive goods and services. And so on. That phenomenon is known as a wage-price spiral, and the key to ensuring it doesn’t spin inflation out of control is to keep wage growth stable (i.e., prevent you and me from getting the fat raises we deserve!).
The August 2023 payroll report revealed that 187,000 jobs were created last month. The unemployment rate jumped from 3.5 percent to 3.8 percent. But the most interesting data was missing from the headlines. The unemployment rate increase was almost entirely due to the rise in the labor force. The labor force participation rate is now at its highest since February 2020. The rate for prime-age participants (ages 25 to 54) is at a more-than-two-decade high.
A higher participation rate is a positive if you are a business with labor-supply problems. And it is good if you are a federal reserve bank trying to stabilize wage growth to cool inflation.
The growth in average hourly earnings was 0.2 percent in August 2023, the slowest pace since early 2022. Annual wage growth remains above 4 percent on a year-ago basis. I expect it will decrease slightly in the coming months as labor supply rises to meet business demand. The year-over-year rate of wage growth would be consistent with the Federal Reserve’s 2 percent inflation target, assuming underlying productivity growth of about 1.5 percent.
Stabilizing wages and inflation should be a tailwind for U.S. stocks. The timing is fortuitous given that the three-quarter earnings recession for S&P 500 companies likely ended in the second quarter of 2023, though we are not technically in the clear as year-over-year earnings growth for this quarter is expected to be barely positive. Still, it signals a turning point. Also a tailwind, future earnings are set to rocket higher (if you believe analysts). Earnings for S&P 500 companies are expected to be about $248 in 2024, compared to $222 in 2023. Believe it or not, I am already beginning to see estimates for 2025 ($278). (I don’t put a lot of faith in 2025 numbers since I expect an economic recession to occur before the end of that year.)
Another reason to believe stocks have room to rise is that the Federal Reserve’s interest-rate-hike cycle will likely come to an official end within two months. According to PGIM Investments, that is something investors can look forward to.
Stock and bond markets have rallied broadly after the completion of the last four Fed rate-hike cycles.
Given the increased likelihood of at least one more rate hike by the Fed and the improving economic fundamentals, I made some changes in my investment portfolios. I moved a bit up the risk curve, selling the iShares Investment Grade Bond ETF (symbol: LQD) and investing the proceeds into SPDR S&P 500 ETF (symbol: SPY), SPDR Short-Term High Yield Bond ETF (symbol: SJNK), Innovator U.S. Equity Buffer ETF, September Serie (symbol: BSEP), and the Direxion NASDAQ-100 Equal Weighted ETF (symbol: QQQE).
Those moves were less an indictment of bonds and more a preponderance of evidence tilting toward portfolio safety.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., 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.
