This is What Soft Feels Like
After what felt like a downpour of April showers, markets rebounded strongly in May, pushing the S&P 500 to record highs. Investors breathed a sigh of relief as inflation came off the simmer following a hot first quarter. Economic data also seemed to level off, quieting concerns that the Fed might need to re-engage its interest rate hiking campaign. The problem with a soft landing is that it may cause conflicting data that oscillate between hot and cold economies.
After several years of investors hanging on Federal Reserve Chairman Powell’s every word, the June Fed decision was passé before Powell took the podium. Indeed, hours before the Fed’s meeting ended, the May Core Consumer Price Index (which excludes food and energy) came in lower than expected at 0.2%. Not only was the CPI report below expectations, it represented a continued step lower from relatively hotter numbers experienced during the first quarter. Bond investors, who are more sensitive to the level and direction of interest rates, cheered, driving long-term rates lower.
Source: Bureau of Labor Statistics
On the other hand, the level of inflation matters much less for equity investors during periods when companies have enough pricing power to raise prices at a faster pace than costs. We can estimate the impact by measuring the inflation associated with producing goods (Produce Price Index or PPI) against consumer inflation (Consumer Price Index or CPI). After being forced to absorb price increases through much of 2022, many companies have rebuilt their margins thanks to a decline in input costs without a commensurate reduction in prices. While recent data suggests that margin expansion may be slowing from 2023 levels, they remain robust.
Source: Bureau of Labor Statistics
At the same time, some investors are increasingly willing to expand their risk appetities, as evidenced by cash flows into speculative assets like cryptocurrencies and meme stocks. Both have seen a resurgence in the last several weeks. Investing in speculative stocks warrants caution may be cliché, but investors would be wise to exercise cautioun. As Seth Heiken, Senior Portfolio Manager and Director of In-House Solutions, wrote in 2021, “Forget YOLO and FOMO, and focus on DCF.” We recommend that investors treat these speculative assets as lottery tickets that offer potentially big payoffs but with low odds of success.
Looking forward, our conviction in so-called traditional assets with strong fundamentals is growing. Assuming that the trend of lower inflation and expanding margins is maintained (even if at times bumpy), we believe that this will support diversified portfolios earning reasonable returns that meet long-term investor needs.