Week of June 17th, 2024

Key Points for the Week

• The summer rally continued last week.
• Stock gains ultimately depend on increased earnings.
• Inflation data finally provided some relief, with the Consumer Price Index coming in below expectations.
• The Fed reigned in expectations on possible interest rate cuts for this year.

Current Trends & News is a weekly financial recap curated by SPC Financial®’s team of wealth management and tax-integrated advisors.* We monitor and explore the intricacies of the financial world and share insights into market developments.

Economic Update

Inflation is lower – and so are some retail prices.

There was a lot of good news last week about the cost of products and services in the United States.

• First, inflation is slowing down. For the second month in a row, inflation slowed. Headline inflation was 3.3 percent year over year, lower than April’s 3.4 percent.

In May, prices for gasoline and fuel oil, new cars, and clothing moved lower, while the cost of shelter, medical care, and eating out increased. Over the last 12 months, the price of used cars and trucks has dropped the most (-9.3 percent), while the cost of auto insurance has increased the most (+20.3 percent).

• Second, wholesale prices dropped in May.

“U.S. producer prices unexpectedly declined in May by the most in seven months, another welcome development that will strengthen the Federal Reserve’s confidence in moderating inflation. The producer price index for final demand decreased 0.2% from a month earlier, lower than all estimates in a Bloomberg survey of economists. Compared with a year ago, the PPI rose 2.2%...”

↳Matthew Boesler, Bloomberg

• Third, some companies are lowering prices. Over the past few years, a lot of companies boosted corporate profits by lifting prices. Now, as consumers pull back on spending, they are reversing course.

“… {company} markdowns, and the consumer spending slowdown that prompted them, mark a turning point in the post-lockdown economy, after the sharpest surge in inflation in decades.… Happy consumers mostly have themselves to thank: The price cuts are mostly due to shoppers pulling back on spending, contributing to a gradual slowdown in economic growth…That means retailers are feeling the pinch. After a period of record-high sales and profits, many are struggling to keep customers and attract new ones. Their answer: lowering prices.”

↳Abha Bhattarai, The Washington Post

It remains to be seen how lower prices will affect companies’ performance and stock values.

This Week in the Markets

Just like last week, it is another week behind us and a strong week for the S&P 500, led this past week by the big technology companies. The spring rally has continued, with the S&P 500 higher seven out of the last eight weeks after pulling back in April.

A strong job market is helping incomes grow, incomes drive earnings, and earnings drives stock prices.

Year-ahead earnings expectations have steadily advanced this year. Ultimately, that is what you need to support stock gains. Earnings expectations can be slow to react sometimes, but right now analysts are not seeing anything that would lead them to shift expectations. If the earnings momentum continues, we may see additional gains for stocks over the rest of the year.

Short-term earnings growth is important, but long-term earnings growth means even more for financial planning. Stocks are a long-term investment that can continue to provide returns above more conservative assets if companies can continue to grow earnings. And companies can grow earnings as long as the global economy grows, which is something it has been doing much often for several millennia.

More practically, as seen below, S&P 500 Index companies have been able to grow earnings along a steady trend over the last 70 years. There have been short-term fluctuations when the economy has slowed, but the overall trend has been strong.

Stock gains are fundamentally about earnings growth. There is a more cyclical element related to valuations, but over time the impact of valuations tends to average out to near flat. The most well-known valuation measure is the price-to-earnings ratio (P/E), which captures the amount investors are willing to pay for a dollar of current earnings as a kind of proxy for long-term earnings. The higher the P/E, the more expensive valuations are. It is true, right now the S&P 500’s P/E is somewhat expensive relative to history (about 20.8 versus a 20-year median of 15.5) but not without reason. The S&P 500 is now dominated by technology oriented companies that can run very efficient businesses, more efficient than the make-up of the index in the past. While that does not necessarily justify current valuations entirely, it does make a meaningful contribution.

There are also areas of the market that are less expensive, such as small and mid-caps stocks. Areas of the market become less expensive by underperforming, which makes many investors uncomfortable. Valuations are not a timing mechanism, but for patient long-term investors we believe that some diversification into other areas of the market can be beneficial, and think we may even see markets broadening in the near term as inflation continues to come under control and the Fed may begin to cut interest rates.

Inflation

The Consumer Price Index (CPI) report was a welcome “surprise” after a string of uncomfortably hot inflation reports. Headline inflation was flat in May, while core inflation (stripping out volatile energy and food components) rose 0.16%, which corresponds to an annualized pace of exactly 2%, all softer than what forecasters were expecting. At the same time, headline CPI is now up 3.3% since last year, and it looks like we have made no progress on inflation since last fall. But a closer look at the data below tells you that shelter (in dark green) continues to keep official inflation data elevated.

Official shelter inflation runs with significant lags to what we see in actual rental markets. Shelter inflation matters a lot for CPI, as it makes up 35% of the basket. Rents of primary residence account for 8% of that 35%, while “owners’ equivalent rent” (OER) accounts for the other 27%. OER is the “implied rent” homeowners pay, and it is based on market rents as opposed to home prices. If you set aside housing inflation, recent inflation trends look very encouraging. Headline inflation is running at a 2.8% annualized pace over the past three months, but if you exclude shelter it drops to 1.7%.

CPI inflation data is backward looking (last week’s number were for May), but the guts of the report, and the trends within, can tell us what we may be looking at on a go-forward basis. There’s good news on that front.

First, shelter. We continue to see disinflation on this front, as the official data follows what we see in private real-time data, albeit slowly. In Q4 2023, rent and OER averaged an annualized pace of 5.4%. That eased ever so slightly to 5.2% in Q1 2024, and in April-May the pace was 4.7%. For reference, the corresponding pace in 2019 was 3.6% (which is consistent with the Federal Reserve’s target of 2% inflation).

Second, inflation at seated restaurants. Interestingly, it is not included in core CPI, but correlates well with it. That is because seated restaurant prices combine several underlying drivers of inflation – restaurant worker wages, commodity prices (food obviously, but also energy prices involved with transportation), and restaurant premise rents. Inflation for this category peaked at 9% year over year in 2022 but it has pulled all the way back to 3.5% – which is where it was in late 2019. It tells me that underlying inflation is not running too hot. In fact, over the last four months food price inflation (groceries) has been flat or negative, and that will likely pull restaurant price inflation even lower. We are also not seeing a surge in wage growth, in sharp contrast to what we saw in 2022.

Third, new vehicle prices. The story up until now has been used car prices and we have seen a lot of disinflation there. But now we are seeing prices for new vehicles pull lower as well – prices have fallen for five straight months. There is more to come as supply chain issues fade further into the background and vehicle assemblies pick up, leading to higher inventories. Meanwhile, private data for used cars suggests used car prices will continue to fall. All of which will exert a downward force on inflation for the rest of this year.

The Fed Is Going to Follow the Data

The Federal Reserve just wrapped up their June meeting and they chose not to move away from the current target interest rate policy of 5.25-5.5%. That was expected but this was an important meeting because they updated their projections for the economy, inflation, and appropriate policy under those scenarios. These policy projections are what is known as the “Dot Plot,” which was last updated in March.

The Federal Reserve raised their 2024 projection for core inflation from 2.6% to 2.8%. (They use the Personal Consumption Expenditure Index, or PCE, which runs a little softer than CPI.) It does not seem like a big shift, except they now project just 1 rate cut (worth 0.25%-points) in 2024, versus the 3 projected in March.

They do have “catch-up” cuts in 2025 and 2026, eventually landing at the same interest rate for 2026 that they indicated in March. They project a total of 9 cuts by 2026, translating to 2.25%-points of cuts (taking the policy rate to the 3-3.25% range).

As Fed Chair Powell pointed out, the dots are based on what Fed officials think could happen. The dots are NOT a forecast of what will happen. Just as the dots shifted between March and June, we could see opinions shift between now and September, especially if inflation continues to ease. In fact, a 2.8% projection for core PCE in 2024 indicates that inflation will run around 2.4-2.5% over the second half of the year.

In any case, the Fed continues to project at least one cut in 2024. But there is some reason to think we may get two, with the first one coming in September followed by another in December.

A Reminder About Scams

Scams usually start with a phone call, email, text, or another form of communication. The person typically claims to be from an agency or organization you know – or one that sounds like it might benefit you, such as the National Sweepstakes Bureau or a lottery.

The person may know your name and address. They may give you their official title or an identification number. No matter how official they seem, you can be confident it is a scam if the person contacting you:

• Indicates there is a problem with your benefits.
• Asks you to pay to receive a prize.
• Suggests that paying will increase the chance of winning.
• Requests financial information, such as a bank account or credit card number.
• Pressures you to act immediately.
• Tells you to pay using a specific method, such as a gift card or cryptocurrency.

If this happens, remember that the Social Security Administration, the Internal Revenue Service, Medicare, and your bank do not call, email, or text to ask for money or personal information. They do not demand that you pay immediately, and they do not accept payment by gift card, prepaid debit card, cryptocurrency, or another untraceable form of money transfer.

When you suspect a scam:

• Hang up or close the message. Do not respond in any way.
• Remain calm.
• Think back over the call. Write down any personal information you may have inadvertently shared.
• Report the scam. Contact the Federal Trade Commission at ReportFraud.ftc.gov. You may also want to report the incident to your state’s attorney general or your local consumer protection agency.
• Share your knowledge. Talk with family, friends, and neighbors about your experience so they know what to look out for.

When you receive a digital message, no matter how official it seems, do not click on any links. Do not give or confirm any personal information, including your name, birth date, phone number, address, email address, place of birth, driver’s license, passport, or Social Security numbers, bank or other account numbers, and PIN numbers.

Being skeptical can keep you safe. Remove yourself from the situation. Do not share information. If you feel anxious and need to confirm that it was a scam, contact the organization using a method provided on their official website.

Corporate Transparency Act

The Corporate Transparency Act was enacted in 2021 and was passed to enhance transparency in entity structures to combat money laundering, tax fraud, and other illicit activities.

Beginning January 1, 2024, certain business entities created or registered to do business in the United States will be required to report identifying information about the beneficial owners to FinCen, the Financial Crimes Enforcement Network. Per FinCen rules, a beneficial owner is an individual or group of individuals who, directly or indirectly, owns or controls the company. Reporting companies typically include:

• Domestic reporting companies: Corporations, limited liability companies, and any other entities created by the filing of a document with a secretary of state or any similar office in the United States.
• Foreign reporting companies: Entities (including corporations and limited liability companies) formed under the law of a foreign country that have registered to do business in the United States by the filing of a document with the secretary of state or any similar office.

FinCen has updated their FAQs that includes new information about the reporting process, reporting companies, reporting requirements and much more, with the expectation that further guidance will be provided in the future. The updated FAQs can be found here.

Did you Know? This Week in History

June 20, 1975: “Jaws” Released in Theaters

On June 20, 1975, Jaws, a film directed by Steven Spielberg that made countless viewers afraid to go into the water, opened in theaters. The story of a great white shark that terrorizes a New England resort town became an instant blockbuster and the highest-grossing film in movie history until it was bested by 1977’s Star Wars. Jaws was nominated for an Academy Award in the Best Picture category and took home three Oscars, for Best Film Editing, Best Original Score and Best Sound. The film, a breakthrough for director Spielberg, then 27 years old, spawned several sequels.

With a budget of $12 million, Jaws was produced by the team of Richard Zanuck and David Brown. Filming, which took place on Martha’s Vineyard, Massachusetts, was plagued by delays and technical difficulties, including malfunctioning mechanical sharks.

Jaws put now-famed director Steven Spielberg on the Hollywood map. Following the success of Jaws, Spielberg went on to become one of the most influential, iconic directors in the film world, with such epics as Close Encounters of the Third Kind (1977), Raiders of the Lost Ark * (1981), *ET: the Extra-Terrestrial (1982), Jurassic Park (1993), Schindler’s List (1993) and Saving Private Ryan (1998). E.T., Jaws and Jurassic Park rank among the highest grossing movies of all time.

Weekly Focus

If only I had more humility, I’d be perfect.

Ted Turner, American Entrepreneur and Television Producer

I fear not the man who has practiced 10,000 kicks once, but I fear the man who has practiced one kick 10,000 times.

Bruce Lee, Hong Kong-American Martial Artist and Actor