Data Indicates the US Economy Continues to Move Forward

Photo Credit: Akshay Nanavati, Unsplash

Weekly Market Recap for January 12, 2024

Investors on Wall Street have been anticipating a further pronounced easing of inflation. This week, the release of the December Producer Price Index (PPI) and Consumer Price Index (CPI) reports showed inflation running slightly hotter than expected. Headline CPI rose 0.3% last month, with shelter costs contributing over half of the overall increase. Over the last 12 months, CPI rose 3.4%, an increase from 3.2% in November and above the Fed’s 2% target.

We would not be surprised to see a sustained general slowing in price growth for goods and services through the end of 2024. However, the long-term trend continues to be favorable. The latest reporting does not suggest any drastic changes are needed to the Federal Reserve’s view of the economy or its interest-rate outlook.

S&P 500 Index (Last 12 Months)

S&P 500 Technical Composite (Last 24 Months)

December Inflation Report

Headline CPI rose 0.3% last month, with shelter costs contributing over half the overall increase. Over the previous 12 months, CPI rose 3.4%, an increase from 3.2% in November and above the Fed’s 2% target. The Core Index, which excludes food and energy, rose 0.3% m/m and 3.9% over the prior 12 months. The December CPI report highlights the bumpy nature of returning to the Fed’s 2% target. Some of the disinflationary impulse from goods prices is slowing, suggesting it will take more than falling shelter prices to get back to 2%. In this context, the market’s 2024 rate-cut forecast still appears aggressive in our view.

Goods Disinflation is Moderating

Manufacturing Activity Contracts at a Slower Pace

In December, the U.S. manufacturing sector registered its 14th consecutive month of contraction, illustrated by the chart below, with the ISM Mfg PMI at 47.4. Although still in contraction, the PMI increased slightly from the prior two months, indicating that manufacturing activity contracted slower. The December report had little new information, with the underlying themes primarily unchanged. The New Orders Index declined from 48.3 to 47.1, indicating that demand continues to contract modestly, and the Prices Index declined due to lower energy prices. The Employment Index remained in contraction as companies continued to manage headcounts, and the Production Index rose to 50.3 as manufacturers maintained their pace of production after a November slowdown. Overall, the data reaffirms the persistent but gradual manufacturing slowdown.

Manufacturing Contracts for 14th Consecutive Month

Services Activity Stalls in December

The ISM Services Index signaled a modest expansion with a 50.6 reading. However, it fell short of the consensus estimate of 52.5 and was two points below November's 52.7. The Employment Index fell to 43.3, the lowest level since July 2020. Respondents commented on workers' preference for remote and hybrid work, making filling positions challenging. In addition, respondents reported an increase in layoffs as companies manage their costs amid an uncertain 2024 outlook. While the overall Services PMI decline is concerning, the report showed that the services sector expanded for the 12th consecutive month. It is difficult to put too much weight on the decline, especially after the Services PMI dropped to 50.3 in May and reaccelerated over the summer months.

US Services Activity

Is the Services Report Cause for Concern?

In our view, not yet. The chart above shows the ISM Services PMI against the next 6-month annualized change in Core Services PCE (excluding Energy & Food). The chart reveals an overall positive correlation. Core Services PCE grows faster over the next six months when the Services PMI rises. In contrast, as the Services PMI falls, Core Services PCE tends to grow at a slower rate. However, the two data points have no statistically significant or predictive relationship. A PMI reading of 60 only sometimes translates into strong services spending, just like a PMI reading in the low 50s does not imply a slowdown in services spending. We will be watching to see if there is a follow-through in January's Services PMI report, but like Mfg PMI, our view is that the report confirms the growth rate is slowing rather than turning negative.

Strong Headline Jobs Report with Weak Underlying Trends

The US added 216,000 jobs in December, while the unemployment rate remained at 3.7%. The report showcased the labor market's resilience, although the data contained some caveats. First, job gains remain concentrated in health care, government, construction, leisure, and hospitality. In contrast, cyclically sensitive industries, like transportation & warehousing and temporary help, posted job declines. Second, the prior two months were revised lower by 71,000 jobs. It continued the 2023 trend of consistently revising estimates lower in later months. The December jobs report tells much of the same story: job growth is slowing, but the overall labor market remains resilient despite the Fed's aggressive rate hikes.

62% of 2023 Job Gains Concentrated in 3 Industries

The divergence in job growth across industries offers a snapshot of the current state of the economy: some aspects are healthy and growing, while others are slowing and contracting. There is no coherent theme or signal to latch onto, with various segments of the economy moving in all directions. Our view is that it will take a significant catalyst to knock the economy off balance in 1H24. While the Fed's tightening could provide the spark, it alone does not appear to be enough to cause a sharp recession.

Putting It All Together

Investors on Wall Street are sticking with their expectations for five to six one-quarter-point reductions in the federal funds rate (5.25-5.50%) from March to the end of this year. Fed officials have been guiding for about three 25-basis-point cuts this year. Market volatility will most likely be more impacted by the Fed's decisions and reported trends in corporate earnings and the broader economy than by the results of this year’s presidential election.

We advise investors to focus on industry leaders, especially those consistently generating solid sales, earnings, and cash flow growth. Top technology stocks may be challenged to match last year’s performance, but further gains are certainly possible. Furthermore, companies in the industrial, healthcare, financial, and consumer staples sectors may possess better price appreciation potential. Overall, a high single-digit market advance is conceivable this year, aligning with the historical averages.

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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