Weekly Thoughts: February 17, 2025
Last week, capital markets dealt with challenging inflation data, as both CPI & PPI came in higher than consensus expectations. Additionally, Friday’s retail sales result of -0.9% in January was the largest decline in almost two years. Nonetheless, equities, despite an opening drop on Wednesday in response to CPI, battled back in the afternoon, partly off optimism of a Trump statement regarding possible progress to end the Russian-Ukrainian war and general underlying market trends. By the end of the Friday, despite problematic data, equities managed to close at 6114.63, +1.47% for the week and just shy of the all-time high of 6128.18.
Bonds response was predictable as yields rose immediately after the CPI result as the 10-year spiked to over 4.65%. However, over the week, even after the follow-on poor PPI result, bonds rallied to a closing yield of 4.478% after the weak retails sales number. ?The other major driver in markets was of course the ebb and flow of tariff headlines. Markets appear to welcome the concept of reciprocal tariffs rather than aggressive, across the board plan from the campaign. In general, investors are wary of tariffs. The idea of targeted, specific reciprocal tariffs in response to existing tariffs foreign governments have had in place against US trade is, in a relative sense, more palatable.
Despite the concerning retail sales result, note the YOY came in a strong +4.2%. The consumer remains resilient. Capex, a large part of our growth potential, is robust, largely led by technology. Note that we often receive push back that we are too reliant on AI capex and certainly, the numbers are huge. We too, believe that at a point in the near future, investors may well demand to see results of this investment and thus, a slowing is inevitable. Additionally, our economy has been reliant of technology as a growing share of our business capital spending. Currently high-tech accounts for over 50% of business cap spending, up from 20% in the mid-1960s. For now, the economy, despite the issues it faces, has a foundation of a strong consumer and robust capex. There is a cycle and reality of a downturn’s inevitable arrival is omnipresent but data tells us this is not imminent.
Returning to the inflation discussion, the CPI +0.5% rise versus expected +0.3%, while rattling confidence, economist David Kelly of JP Morgan, pointed out that there were some “flaky” underlying numbers such as airfare & insurance and has a belief that reversals over the coming months may well result in some lower-than-expected months. The takeaway for us is the data affirms the already in place Fed view of patience and being on hold. However, the economy thus far is providing cover for the Fed as employment remains strong therefore, the rush to ease to protect labor is just not a deep concern at this point. It is fair, however, to conclude that we have most assuredly passed the point of disinflation. We are stuck solidly above the 2% target and the concern is that higher for longer rates will eventually push against growth, whether high mortgages slowing housing sales and auto sales or corporations, especially smaller ones, roiling over maturing debt.
While our concern of reaccelerating inflation is higher than it had been, there remains a solid possibility that this report is another example of seasonal adjustments distorting the data. Many businesses raise prices at the start of the year and modeling becomes a bit more challenging than most other segments of the calendar. We expect the data to improve in Q2, just like last year when January experienced an unwelcomed upside surprise. The behavior of both stocks and bonds as the week progressed, even in the face of higher-than-expected PPI, tells us investors need to see a trend develop and conclude month to month economic indicators often show volatility.
The upcoming week is kicked off with the President’s Day Holiday and thus we have only four trading days. On Wednesday, Housing Starts and building permits are released. While important, unlikely to be a large impetus for a big move in markets. A primary driver for day-to-day movement will likely be news out of Washington, as the Trump Administration is moving fast on their initiatives. The tariff environment will be volatile as his willingness to name a rate and start date, only to adjust if the foreign leadership will engage in negotiation makes it challenging to model on the economic impact of said tariff. We will also note that once a tariff is started, the length of time in place will be impossible to predict. As we said earlier, the [so far] retreating from the across-the-board initiation of tariffs for now is a positive development as this could mitigate the negative outcomes [potential slowing of growth or increasing of a one-time boost for inflation] while still leading to possible negotiation.
As we work through the final two weeks of February, the build up to the key PCE Index takes on greater significance than usual after last week’s inflation results. Thus far in 2025, despite hotter than hoped for inflation & tariff concerns, a healthy economic underpinning has been able to rule the day. Nonetheless, market participants will only have so much patience for inflation stickiness, especially at these valuation levels.