Last week, I discussed the potential for inflation to make a comeback as commodity prices have been on the rise. Just yesterday, we saw the release of the CPI numbers, which came in at 3.6%, just a tad higher than the anticipated 3.5%.
The increase in the CPI numbers doesn’t surprise me, but I expected them to be even higher. It seems there might be a delayed effect at play, and we could see the CPI figures climb further in the upcoming months as the effects of higher commodity prices begin to cascade to consumers. At this point, it appears that producers are the ones feeling the brunt of the cost increases.
Naturally, stocks reacted negatively to the inflation data. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite each fell by 1%, while the small-cap Russell 2000 Index saw a more significant drop of 3%. These declines aren’t catastrophic, but given the low volatility we’ve experienced and the absence of a 1% drop for months, it seems we’ve become unaccustomed to such movements and the drop felt scarier.
The final push to lower inflation could prove the most challenging. The situation is further complicated by the U.S. increasing tariffs and taking measures to prevent China from introducing cheaper goods into the market. Additionally, the restructuring of the global supply chain is set to elevate production costs. With these policies in place, prices are poised to rise, especially as the full impact of higher commodity prices has not yet been felt.
Therefore, I believe that the CPI figures will not achieve the 2% mark in 2024, and I anticipate they will rise in the coming months. A significant concern is the possibility of the Fed postponing rate cuts, a move the markets have been counting on to fuel a rally.
Yet, not all hope for a rate cut is dashed. Despite the unlikely scenario of inflation rates decreasing to the Fed’s target of 2%, the Fed has hinted that a rate cut remains on the table, provided they are assured inflation is under control, whatever that means.
Market expectations for interest rate cuts have indeed been postponed this year. As of the third week of March, the anticipation was for the first rate cut to occur in June. However, current expectations have adjusted, with forecasts now indicating that rates will hold steady, and the initial rate cut is projected for September. Furthermore, whereas three rate cuts were initially expected in 2024, forecasts have been revised down to just two.
Since the year began, bond yields have been on an upward trajectory, with the US 10-year Treasury yield increasing from 3.9% to over 4.5%. The Wall Street Journal highlighted that a recent auction of 10-year Treasury notes saw the weakest investor participation since November 2022.
This trend may indicate investors’ concerns that yields could rise further, suggesting they might secure better returns by waiting. Particularly, those who invested early in the year anticipating rate cuts are now facing paper losses. Low demand can lead to a self-fulfilling cycle, depressing bond prices and elevating yields even further.
Elevated bond yields in turn exert pressure on the stock market by increasing the discounting factor used in valuing stocks, which can lead to lower stock valuations.
You might say I’m hoping for a market pullback. While I remain committed to long-term investments, I’ve reduced my short-term exposure, noting that stocks have experienced a relentless upward trajectory since October 2023—a span of 5-6 months without interruption.
Drawing from Mark Minervini’s historical analysis, the S&P 500 has now gone 280 days without a single-day decline of 2% or more. This level of stability has been surpassed only five times since 1965, signaling that stocks may be overextended and a correction could be due.
The elevated CPI numbers, looming inflation worries, and the delay in rate cuts provide strong justification for a recalibration with the updated assumptions. I am indeed eager for this pullback to unfold, allowing us to move past the current uncertainties and pave the way for the next bull run.
