IT’S STILL HERE!
I was not sure whether to title this “It’s Still Here” or “It Never Left”. Of course, the “it” is inflation, and the release this morning showed that CPI grew by 0.3% versus the consensus view of 0.2%. Ex food and energy, inflation grew even faster with a monthly increase of 0.4%, and annual headline inflation grew by 3.1% versus the consensus expectation of 2.9%1. If there was anyone still hanging out there who thought the Fed might just cut rates in March, this release was the nail in the coffin that we will not see that cut.
Several weeks ago, I wrote a post concerning the difficulty in fighting the last piece of inflation to get back to the Fed target of 2.0%. The reality we must confront is that the elongated period of extremely low inflation may have been the exception, not the rule, and the “neutral rate” for inflation may be slightly higher. We have been watching as the markets continue to stretch to extremes. Stocks are setting new highs; Nvidia and AMD seem to have an unlimited upside. This is, of course, until they don’t. When we look at the bond market, credit spreads continue to be extremely tight, indicating that the corporate bond market is priced pretty close to perfection. Again, this is until it is not.
We have never been market timers and are not about to start now! That said, when we reach these types of levels I am often asked by people, “What should I do?”. We always go back to the basics and recommend rebalancing portfolios to target levels. Sometimes, in periods where valuations are stretched, rebalancing through your target to the lower end of the range may allow investors to realize profit and reduce risk. Investors need to take the view that they are rebalancing and should not look at the subsequent market moves.
The fear of missing out, or FOMO, is not healthy for an investor. We need to make decisions that fit our term plan, and taking profits means you may leave some on the table. I always say this is okay. We do not espouse taking the view that the S&P 500 set a new high, therefore, it will need to correct, so on that basis, one should sell stocks, go to cash, and reinvest at a later date. The problem with that strategy is that you need to also define the event or market level to get back in, and that is a very tough thing to do in practice.
Ultimately, we think this last battle with inflation will continue to be difficult. At the same time, we think the Fed is up to the task and they are not going to abandon the fight. I think it is critical to not only think about the start of the easing cycle but to also recognize that a rate increase could be on the table if inflation does not actually start to slow down. More to come!