Morning Market Commentary:
- The U.S. Bureau of Labor Statistics releases its December Producer Price Index today.
- The numbers are likely to show a continued decline in inflation growth.
- This should take pressure off the Federal Reserve to keep raising interest rates.
Manufacturing data are signaling a further slowdown in inflation...
This morning, the stock market will face another key test. You see, the U.S. Bureau of Labor Statistics ("BLS") is set to release its Producer Price Index ("PPI") growth data for December. And the results will tell us whether or not the Federal Reserve needs to keep aggressively raising interest rates.
Just last week, we saw household inflation ease when the BLS released its Consumer Price Index ("CPI") metrics for December. Prices jumped 6.5% year over year compared to the 7.1% surge in November. The reading was the lowest since October 2021. And it marked the sixth consecutive month that the CPI remained below the 9.1% peak from June 2022.
Inflation indicators we observed from December showed that the costs for companies to produce goods keep falling. And more recent data tell us the trend has continued into January...
In other words, today's numbers are likely to diminish the need for the Fed to keep raising interest rates. That should give both retail and institutional investors the confidence they need to invest more money in risk assets like stocks.
But don't take our word for it. Look at what the data are telling us...
Every month, regional Federal Reserve banks gauge business activity within their districts. Their research teams send surveys to manufacturing executives in their areas, asking them about current business and what the state of activity might be six months down the road.
We combined the data from the Dallas, Kansas City, New York, and Philadelphia Feds' surveys. These figures are important when we consider the scope of each of those regions as it relates to the national economy.
According to the U.S. Bureau of Economic Analysis, Texas accounts for 9.4% of domestic economic output, New York makes up 8.1%, Pennsylvania is 3.7%, and Missouri is 1.5%. In other words, they make up over 22% of U.S. gross domestic product. That means trends in these Fed districts have more of an effect on what's taking place nationally.
But for this conversation, we want to pay attention to one measure in particular... the prices paid index. It tells us what manufacturers are shelling out for raw materials to produce goods. We can think of it relative to the PPI. Take a look at the following chart...
As we can see, the measure is a leading indicator of the direction of inflation. It peaks or troughs right around the same time as the PPI. Our combined index for December showed prices paid dropped, meaning manufacturing costs likely fell.
Now, look at yesterday's numbers for January from the Federal Reserve Bank of New York. The manufacturing cost index had a reading of 33 compared with December's 50.5 and April's all-time high of 86.4. In fact, it hasn't been this weak since November 2020...
That tells us there's room for PPI to head even lower when January's numbers are released next month.
Money managers investing for eight to 12 months down the road want to see this trend. It speaks volumes to them about the potential for an economic rebound...
You see, the central bank's next monetary policy meeting will start on January 31 and last until February 1. At that time, it will decide how much more it should raise interest rates. Currently, policymakers are guiding for a rate hike of between 25 and 50 basis points, getting the federal-funds target rate to a range of either 4.50% to 4.75% or 4.75% to 5%.
If inflation growth keeps slowing, it means prices for goods are stabilizing. This tells the Fed that its rate hikes are working, which means it can stop raising them. And at this rate, we may even see costs start to drop by the middle of 2023. This could give the central bank room to consider cutting rates.
Now, look at the returns for the S&P 500 Index at the end of every rate-hike cycle since 1980...
If we were to see a slowdown in inflation and the Fed potentially pausing – or even cutting – rates, households would feel less pressure to save money in anticipation of future cost increases. Instead, they'd feel more confident about spending it again.
Institutional investors realize the outsized economic growth experienced during 2021 due to massive amounts of stimulus is unsustainable. They want to see economic activity revert back toward the mean. That way, they can get a better idea of what the true supply and demand picture looks like.
Then, as analysts and portfolio managers have a better sense of what companies' future earnings look like, they can place fair-value multiples on stocks. This will help remove asset managers' unease toward the market.
In turn, we should see money going back to work buying up high-quality assets and rallying the S&P 500.