Markets continue to be driven by artificial intelligence stocks (AI) as well as frontrunning the timing of the Fed's first rate cut since the start of the pandemic during March 2020. Beyond the day-to-day swings, these drivers reflect important trends in innovation, productivity, and the health of the economy. They are also the result of the pandemic-era easy money policies and fiscal stimulus measures that led to booms in the tech sector and rapid price increases. As the dust hopefully settles on the inflationary episode of the past few years, what should investors do to maintain perspective in their portfolios?
It is clear that the various supply and demand shocks are fading. Some prices remain stubbornly high, such as those for shelter (i.e., the cost of rent and mortgages). However, most measures have improved significantly. This sets the stage for the widely anticipated Fed rate cuts later this year. During the recent Fed meeting on March 7th, Fed Chair Jerome Powell emphasized that inflation is "not far" from where it needs to be for the central banks to begin the process of cutting rates. Since then, the market has rallied roughly 1.5%, which, we believe, gives the S&P 500 a strong temporary "floor" in the markets. Although we see the market as fairly valued at these levels, we do see downside protection, especially coming into what we think will be a stronger than expected earnings season along with the anticipation of a rate cut(s) later this year.
The latest Consumer Price Index report, for instance, showed that prices during February rose 3.2% on a year-over-year basis. This represents a slight uptick from the prior month due to an increase in energy prices along with shelter costs noted above. Energy drove the Producer Price Index higher as well, although both the headline and core measures remain at or below 2% y/y. These data points are consistent with consumer price inflation that is heading back toward 2%. This will take some time. We believe energy prices will continue to remain elevated around these levels – which could make this last push to 2% a bit more difficult. Not to fret, as the stock markets can continue to do well with energy prices elevated.
Although many parallels have been drawn to the inflationary shocks of the 1970s and early 1980s, the policy response and economic outcome could not be more different. In the 1970s, the Fed switched direction multiple times as it grappled with the concept of "stagflation," or the idea that inflation could rise even as demand was weak. Fortunately, perhaps because that period was studied so extensively by current policymakers, stagflation has been avoided this time around.The bottom line? Investors should continue to focus on broad economic trends and historical perspectives rather than on day-to-day market swings in specific stocks.
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