Investors put on rose-colored glasses this week, enabling them to view all economic news as positive even when it was not. Psychology is driving stocks higher. I won’t fight the upward trend, but I also won’t be chasing stocks higher at a time when the Fed is selling securities.
The Week That Was
May inflation data were mixed. The good news was the total consumer price index increased by only 0.1 percent, bringing the year-over-year increase to 4.0 percent. The bad news was all of the lower inflation was due to a 6 percent decline in energy prices. The more stable core inflation (ex-food and energy) rose by 0.44 percent, which is a 5.4 percent annualized rate. This w s up from the 5 percent annual rate increases over the three-, six-, and 12-month periods.
In contrast to consumer inflation, the May producer core inflation was only 3 percent for the year and at a 2 percent rate for the past six months. Hence, producer prices provide the potential for further easing in prices for consumers.
In addition to an ongoing weakness in retail sales, tax receipts show problems with the economy. With three quarters of the fiscal year over, tax receipts to the Treasury are down 11 percent from the first eight months in the prior fiscal year.
Weekly employment numbers for the second week in June continue to show a modest increase in initial unemployment claims. Claims are at 262,000, up from an average of 220,000 over the past year.
Things to Come
The Homebuilders Index for June should be close to May’s 50, right at the breakeven level
Pressure from mortgage rates approaching 7 percent is offset by a shortage of new homes. The net effect of these suggests little change in new home activity.
On Friday, S&P will report its flash estimate of business activity in early June. The May report showed a strong pickup in the service sector. A rival ISM survey showed the service sector close to break-even.
It will be interesting to see if S&P’s upcoming service company survey reflects any of
the weakness indicated by retail sales and tax receipts.
Money, Money, Money
The yield curve remains significantly inverted (a predictor of recessions), confirming serious monetary restraint. Despite pausing its interest rate increases, the Fed intends to sell $95 billion in securities each month, further tightening monetary policy.
Our analysis shows the amount of money in the economy in mid-May was down 17 percent, buit it was up 20 percent from two years ago.
Market Forces
Stocks moved sharply higher this week with the S&P500 up another 1½ percent. The latest surge represents a 24 percent gain from the October, 2022 low, but it is still down 7½ percent from its all-time peak of 4,797 at the beginning of 2022.
Although the economic news was mixed, investors looked upon each major news item as positive.
Investors liked 4 percent year-over-year inflation being the lowest in two years, choosing to ignore that core inflation rates remained at 5 percent.
Investors celebrated the Fed’s pause in raising rates, while ignoring the Fed’s expectation of two more increases by year-end.
Investors ignored May retail sales data showing sales were down from the first quarter and up only 1 percent over a year ago.
While the consensus now expects a soft landing with higher earnings, we expect negative real growth and lower earnings.
While the surge in optimism drives stock prices higher, I continue to believe the market is vulnerable to a setback caused by the monetary restraint.
Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 15 percent
Monetary Policy: restrictive
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