SUMMARY: Most investors we surveyed are optimistic that CPI is on a Fed-friendly glide path without a significant tightening of financial conditions or recession. That is a change from last November when a recession and tighter FCI were more popular responses. To start 2024, 50% of investors we surveyed thought the biggest market risk in 2024 was weak economic growth. Given where consensus has moved on inflation there is an underlying condition to be aware of from a risk management point of view. As Gerard notes (HERE), goods inflation has come down a lot, which has been a major positive, but the odds are high that goods will stop helping as much. If Core services ex housing, or “supercore” inflation stays around current levels, less goods disinflation implies overall core inflation will remain above the Fed target.
Gaming out today and beyond, if the CPI is dovish, but it is driven by rents and core services inflation increases MoM, that is not super positive. The entire world knows rents are falling and that will drag down YoY core readings over the next few months. Core service inflation needs to decelerate as goods disinflation stops helping as much. If wage growth is moderating (wage readings are still critical) and the supply side of the economy has improved, core services ex housing inflation should decelerate.
Equity Internals: Equity internals are just starting to reflect the recent economic growth optimism. Risk-on factors, small caps, and Value have rebounded over the past week or so (more details on market internals HERE). At the same time, Investors are “all in” on US Tech stocks according to the Bank of America investor survey. FYI – There are still extreme valuation gaps that should continue to normalize as pricing reflects lower tail risk (consistent with the above). Small caps NTM PE rising from its 13th percentile to its median would imply an +11% return vs the S&P. FYI, John Roque thinks the R2K is in strong technical position. He is looking for a retest of the 2021 highs. Details at the end of this report.
MARKET VIEWS: Yesterday we surveyed investors ahead of CPI today (full results HERE). Most investors are optimistic that CPI is on a Fed-friendly glide path without a significant tightening of financial conditions or recession. That is a dramatic change from last November, when a recession and tighter FCI were more popular responses. Equity internals are starting to reflect this optimism (check out our note recapping last week’s performance HERE). Yesterday, the Russell outperformed the S&P 500 by +185bps, Realized Value returned +138bps long-short, and Earnings Turbulence vs Low Vol (MS22RISK Index on bbg) returned +103bps.
There are still extreme valuation gaps that should continue to normalize as pricing reflects lower tail risk (consistent with the above). If small caps NTM PE rises from its 13th percentile now to its median, it would imply a relative return of +11%. The PE spread between small caps and large caps ex the mag 7 is still only at its 25th percentile.
CPI RISK MANAGEMENT, LONGER-TERM: We share the optimism about CPI near term. And yesterday there was some fresh data that illustrated the reasons for optimism nicely. All inflation expectations (1yr, 3yr, 5yr), in the NY Fed consumer expectations survey are trending lower. The rents portion of the survey gapped lower. It’s well-covered that rents will be disinflationary moving forward, and we wouldn’t push back against that.
Given where consensus is at with inflation now, there is an underlying condition to be aware of for risk management though. As Gerard notes (HERE), goods inflation has come down a lot, which has helped, but odds are goods will stop helping as much. Wage growth still being high on an absolute level may be evidence that the labor market is actually tight. If this is the case, “supercore” service inflation would stay sticky going forward. Again, not a problem tomorrow, but something to be aware of for risk management this year.
Source: BEA, FH calculations
Data are actual to January.
I prefer the MPO version of the Powell Supercore to the standard, for reasons I have been over in earlier notes.
FYI, John Roque thinks the Russell 2000 is catching a momentum wave and entering a new bull market. He is looking for a retest of the 2021 highs.
