Stocks show investors still expect a smooth transition to lower inflation and lower interest rates. The past year’s monetary restraint suggests otherwise.
The Week That Was
The August consumer price index (CPI) numbers show the Fed has more to do to limit inflation. A 10 percent monthly increase in oil and gasoline prices raised the total CPI by 0.6 percent (an 8 percent annual rate). Core CPI, a more stable measure, was up at a 3.4 percent annual rate.
The six-month core inflation measure is the most reliable indicator of the current inflation rate. In the six months ending in August, the annual rate was 3.7 percent. Most of the inflation measures confirm the current rate is somewhere in the vicinity of 3 percent to 4 percent.
Things to Come
Today’s release of the September Homebuilders’ Survey will provide the most up-to-date view of market conditions for new houses. We expect housing activity has been close to break-even at the August reading of 50.
Tomorrow’s report on August building permits and housing starts should continue to show a
depressed housing market.
At Wednesday’s Fed meeting the target fed funds rate will remain unchanged at 5.3 percent. What is less certain is whether the Fed will continue to sell securities. We believe it will keep selling them.
If the Fed does continue selling securities, monetary policy will become more restrictive. This would increase the likelihood of a sharp decline in business activity in 2024.
On Friday, S&P will provide its advance business survey for early September. The August survey showed the service sector almost at break-even. This reported weakness in the service sector was the opposite of what the ISM business survey reported. Expect September business surveys show weakness as economic conditions become more precarious.
Market Forces
Stocks continue to yo-yo up and down, lacking a clear sense of direction.
Last week the S&P500 was little changed following the previous week’s decline. The past week’s news failed to make an impact on stocks. The market had no negative reaction to the CPI report showing an increase in August inflation numbers. The only good news on inflation was that the damage was less than expected.
Stock prices also were helped by a report showing August retail sales increased at a 5 percent annual rate. The increase promoted the idea the economy continues to progress and is not declining.
Finally, stocks were encouraged by Fed members indicating they would almost certainly pause interest rate hikes at next week’s meeting.
More important than the decision on interest rates is whether the Fed will continue to sell securities. We expect they will and thereby risk a serious downturn next year.
Although the economic numbers remain mixed, I expect the economy to weaken significantly in the months ahead. Unlike the fixed-income market, the major market indexes have consistently underestimated the potential weakening in the economy.
As the economy’s problems become more apparent, it is likely to put downward pressure on stocks.
Outlook
Economic Fundamentals: neutral
Stock Valuation: S&P 500 overvalued by 16 percent
Monetary Policy: restrictive
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