June Private Client Letter

As I have repeatedly observed, the rate of inflation has been the dominant economic story of the year.  Consumer prices are now about 20% higher than they were when inflation began to heat up and, while the rate of continuing inflation has fallen from peak levels experienced in the summer of 2022, it remains well above the Fed’s 2% target and continues to pressure consumers.

Over the past year, the consumer price index rose 3.4%, which is an acceleration from the 3.0% increase during the previous twelve-month period.  While consumer prices rose only 0.1% in May, the year-to-year gain would come in at about 3.3%, still higher than in mid-2023.

The Fed’s preferred measure of inflation is the PCE deflator, up 2.8% from a year ago.  The Fed also has referenced something called “Supercore” inflation, which is PCE prices excluding food, energy, other goods, and housing.   That measure is up 3.4% from a year ago and has recently accelerated to an annual rate of 4.1% in the past six months.

At the beginning of the year, the market was convinced the Fed would cut rates five or six times in 2024 predicated on lower trending inflation numbers.  With inflation proving sticky, and possibly reaccelerating, there have been no rate cuts this year.  Accordingly, there appears to be virtually no chance of rate cuts coming from next week’s Fed meeting, or at their following meeting in late July.

Some Fed officials are now signaling a more hawkish tone relative to monetary policy.  Minneapolis Fed President Neel Kashkari has gone as far as saying a rate hike could not be ruled out.

The U.S. economy continues to expand, inflation remains stubborn, the labor market appears tight and stock markets have been moving higher.  The S&P 500 and NASDAQ finished the month of May trading near all-time highs.  Equity returns over the last year have been well above average ranking right near the 80th percentile relative to all other one-year periods.  The last two, five, and ten-year returns are also above average.

While corporate earnings have been generally resilient, the results have been mixed for many companies beyond the strong results of a handful of tech titans.  The NASDAQ Composite is not the Nvidia Composite and an increasing number of stocks have started to struggle.  Unless an investor owned Nvidia, it wasn’t feeling anything like a market at all-time highs.

Recent economic reports have not been pretty in terms of economic momentum.  Activity in the U.S. manufacturing sector has contracted for eighteen out of the last nineteen months.  The May report missed consensus expectations once again, falling deeper into contraction territory with a reading of 48.7. 

Employment data has been showing signs of cooling off following its previously robust profile over most of the past year.  Of the seven indicators in the category, only jobless claims and Challenger Job Cut Announcements showed improvement in their recent year-over-year readings.  The Housing sector has also shown weaker momentum in recent months as well; with negative momentum in two of the last three months.  Here again, Building Permits, Housing Starts, New Home Sales, and Existing Home Sales, and Pending Home Sales all declined on a year-over-year basis.

Measures of the consumer were positive in February and March but turned south in April.  U.S. consumers have worked through their excess savings and a recent retail sales report reflected softening in spending.  Credit card balances rose 13.1% in the first quarter and the average credit card interest rate of 20.66% is near an all-time high.  This increased reliance on debt at high interest rates has driven an increase in delinquencies, which jumped 29% in the first quarter to 6.9%, above the 15-year average of 5.3%. (Bloomberg).

The second quarter GDP estimates have been downgraded to the mid-2% range from the mid-3% range earlier this year, but to be clear, the economy is not falling apart.  Still, investors appear to be crossing their fingers that economic activity is not slowing, or that the Fed will aggressively cut rates should the economy begin to tip over. 

Given the recent weakness in economic reports, persistent inflation, and stretched valuations – I can only imagine that the equity markets are at risk of becoming more volatile as the year progresses.

This week all eyes will be focused on the 2-year Treasury yield which recently moved back up near previous cycle highs.  Any meaningful move above these levels could be seen as bearish given long-term bonds would likely move higher as well.  The other important headline will come from the May payroll report which will be released on Friday.

We began 2024 by signaling a cautious tone.  Our Outlook 2024 report (published in January) concluded with the following observation:

“We believe investors should remain constructive in 2024 while being especially attentive to the unique risk patterns present in our economy and around the globe. The potential headwinds we may encounter in the coming year suggest a range of possible outcomes that are wider than we would normally expect.”

We continue to hold this opinion in what is proving to be an interesting year.

As always, thank you for your continued confidence in our abilities to help you navigate the many challenges associated with growing and protecting your wealth.

John E. Chapman

Chief Executive Officer

Chief Investment Strategist