Wednesday, March 29, 2023

Inflation, Employment And Interest Rates


The Consumer Price Index () for October came in unchanged from the prior month. Inflation is still running low (1.7% year over year) given the downside pressure COVID is wreaking on the jobs market and overall economic activity.


Low inflation keeps the Fed in play. I’ve heard the “Fed is out of bullets” argument for over 10 years. Inflation is really the only thing that can hinder the Fed. The dual mandate is full employment and inflation averaging above 2% for “some time”. Neither criteria is close to being met.

Low inflation is also supportive of higher stock valuations. Growth stocks tend to outperform in low inflation, while value and dividend stocks tend to outperform during periods of above average inflation. This is not an exact science however.

Weekly Unemployment

The above chart of weekly shows part of the reason for low inflation. Weekly unemployment claims continue to trend lower, but at 709K, it’s still about 3x more than the pre-COVID average.

Continuing Claims

ticked down to 6.786 million, but still above the highs during the 2008 recession. While the odds of a return to normal by this time next year are increasing every day, the current situation is moving in the wrong direction. Additional restrictions would obviously put downside pressure on economic growth and employment, which would only be exacerbated without some fiscal stimulus. I do expect a scaled down fiscal stimulus package to be agreed upon during the “lame duck” session of Congress. Time will tell.

Treasury Yield

In a normal interest rate environment, I’d expect to see the in the range of 3-4%. We were headed in that direction. The 10-year hit 3.25% in late 2018, until the trade war and COVID pushed rates back to record low territory.

The chart setup above shows the key swing high just reached at 0.957%. Rates moved up a bit after some of the election uncertainty was taken off the table. But given low inflation and high unemployment, I think there is a good chance this will prove to be resistance in the near term. A break above however, would put a target of 1.336% to 1.429% in play. I just can’t see rates getting higher than that until there is a return to normalcy. But who knows.

Yield Curve

The yield curve (difference between two-year treasury rates and 10-year treasury rates) has moved up to 80 basis points, which is a level not seen since 2017. A higher spread between the two rates is healthy. Generally this favors the financials, but I still can’t bring myself to put that much money to work in that sector. I own JPMorgan Chase (NYSE:) and Berkshire Hathaway (NYSE:) currently, with Morgan Stanley (NYSE:) and Goldman Sachs (NYSE:) on my watch list. Otherwise I still like Tech and Discretionary, with a bit of industrials and basic materials. I’m increasing my exposure to health care as well (I’ll elaborate on this during Monday’s earnings update).

Summary: Inflation is still low, and unemployment is still high. The Fed remains in play and some fiscal stimulus is likely coming within the next few months. Economic growth is moderating from the record Q3 results, but still growing. Rising cases puts the threat of disruption at the forefront. I don’t foresee this as being enough to push the economy into a double dip recession. But there is much outside of anyone’s control.

Because there is such a wide range of potential outcomes, it is important to remain well diversified. This is not the time to pile into the areas of the market that have outperformed. Remember, the markets are cyclical. The outperformers eventually turn into the underperformers (and vice versa). The key to successful long term investing is to not get too excited when things are good, and not get too pessimistic when thing

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