Wentz Weekly Insights
Inflation Still Too High

For the second straight week small caps outperformed large caps with the Russell 2000 rising 1.13%, which could be an early sign of the markets rotating. In addition, the S&P 500 snapped another winning streak and before last week’s 0.42% decline, the index was up 14 of the past 15 weeks. The NASDAQ was the underperformer for the first time in weeks after registering a 1.34% decline as several of the mega cap tech companies like Alphabet and Apple saw declines after a big run higher.
Stocks had no real direction last week, with the broader market trading back and forth mostly driven by economic data, with many other micro headlines from company earnings reports. The focus last week was on the inflation data from the consumer price index and producer price index. Both indexes showed inflation was higher than expected in January, which led to a decline in stocks both days the data were released due to the thought interest rates would need to stay higher for longer.
The consumer price index showed a 0.3% monthly increase at the headline level with core price rising 0.4% (excludes food and energy categories which tend to be more volatile month to month). At the same time the annual rate was 3.1% and 3.9%, respectively, which is nearly double the Fed’s 2% annual inflation goal.
The inflation picture has been the same for months now – the areas seeing high inflationary pressures are housing (which is the shelter category in the data reports) and services. Goods inflation has come down to a normal level, with some categories seeing deflation, due to the normalizing of the pandemic effects and supply chains.
However, one of the indexes we have been watching and believe the Fed continues to watch is a reading called super core, which excludes shelter, food, energy, and goods, and is a better indicator of inflation of the services sector. This index saw a large jump of 0.8% in the month which was the largest monthly increase since the beginning of 2022, and is up 4.4% over the past year. Even more, that index is up 6.7% annualized over the past three months, suggesting services prices have actually accelerated, not decelerated. Prices for transportation have seen the biggest jump, followed by medical care services. Meanwhile, grocery prices have normalized as well as used car prices and apparel.
As with most highly anticipated reports like this one, markets reacted immediately. This move was to the downside, with the Russell 2000 seeing its worst day since mid-2022 with a 3.96% decline and Treasury yields jumping. Markets were looking for another month of data that supported the view that inflation was continuing to cool and would soon return to the Fed’s 2% objective. This would provide further evidence for the Fed and support the start to cutting rates sometime in the first half of the year.
However, after the data this week, the market is pricing in a 25% chance rates are unchanged through the first half of the year, up from just a 5% chance at the start of last week, according to the CME FedWatch Tool which measures market pricing of interest rate futures. In addition, by the end of the year, the pricing suggests three to four rate cuts, compared to five at the beginning of last week, and compared to seven rate cuts expected at the beginning of the year.
The other big data release last week was January retail sales. Retail sales fell 0.8% in the month, a huge miss to the downside with weakness seen across the board – 9 of the 13 categories saw declines. Lower sales were driven by weakness in building materials, vehicle sales, miscellaneous stores, and health/personal care. One of the strongest categories relates to the services sector and that was restaurants and bars seeing a solid increase in the month.
For both the inflation and retail sales reports, weather may have been a contributing factor as much of the country saw a cold stretch in the month, and as we know weather does affect spending patterns. As many of the Fed policymakers have said in recent weeks, more data is needed to gain greater confidence of a slowing inflationary environment. Months where we see this data will likely push out possibly rate cuts further, but weaker economic data will also suggest weakening economic activity and raise recession risks.
Markets focus this week will shift back to AI (artificial intelligence) with the release of quarterly financial results from AI chip developer Nvidia. Its stock reaction the day after its past four quarterly reports have been +14%, +24%, 0%, and -2.5%, and is up 250% in the past year. So much focus has been on the investment in AI over the past year and the focus on its conference call this week will be the guidance it gives for the upcoming quarter for any clues on if that growth has continued. Although Nvidia’s stock makes up 4.2% of the S&P 500 index, this one report by Nvidia has the ability to move the market and shift sentiment, possibly more than this past week’s inflation data.
Week in Review:
US stocks got off to a mixed start on Monday, it was a stronger day for small caps with the Russell 2000 seeing a 1.75% gain, but the S&P 500 was down slightly. It was a light day of headlines with perhaps the biggest being the New York Fed’s survey of consumer expectations showing one-year inflation expectations unchanged at 3.0% with longer-term expectations falling slightly.
Tuesday pre-market started lower on less exciting earnings results overnight. However, the main event for the week was Tuesday’s inflation data that came in a little hotter than expected with a 3.9% 12-month increase in the core index. Stocks immediately fell further while Treasury yields moved to the highest level since November. Meanwhile, the odds of a rate cut in March moved to 6% from near 20% prior to the inflation data. Stocks ended up moving off the lows of the day to still finish down 1.37% while the Russell 2000 had its worst day since June 2022 with a 3.96% decline.
Stocks bounced back on Wednesday with some talks the inflation data could have been the result of the “January effect,” in addition to dovish Fed comments downplaying the recent hotter inflation data. It was a less active day with just company specific headlines and the S&P 500 rising 0.96%.
Thursday saw an inflow of economic data with the main reading on retail sales that disappointed with a 0.8% decline that was spread across 9 of the 13 major categories. Stocks shrugged this off and continued to move higher based on the thought weakening data could mean rate cuts sooner. Small caps outperformed with a 2.45% gain in the Russell 2000 while the S&P 500 rose 0.58%.
Stocks saw another weak start to the day on Friday after another inflation reading came in hotter than expected, this time from the producer price index which measures inflation at the producers level. In addition, earnings were very mixed again with a couple disappointments and Fed talk included remarks that January’s data has been messy which is why the Fed needs more time to gain greater confidence to cut rates. Stocks ended near the lows of the day with the Russell 2000 down 1.39% and S&P 500 down 0.48%.
U.S. stocks indexes finished the week mostly lower with the exception being the small cap Russell 2000 index. Despite a nearly 4% decline on Tuesday, small caps finished the week positive by 1.13%, while the other indexes finished as follows: Dow -0.11%, S&P 500 -0.42%, and NASDAQ -1.34%. Treasury prices were lower across the curve as yields rose with the 2-year yield up 16 basis points to 4.64% and 10-year yield up 11 bps to 4.28%. Meanwhile, the dollar index was up 0.2%, gold fell 1.2%, and oil rose 2.1% to its highest level in three months on increased Middle East tensions.

Recent Economic Data

  • The consumer price index, one of the most common inflation readings, rose 0.3% in January, slightly above the 0.2% expected. Over the last 12 months the index is up 3.1%, slowing from 3.4% from December, but also 0.1% higher than expected. Core prices were the same story – the index excluding the volatile food and energy categories rose 0.4%, which was 0.1% more than expected with the 12-month change at 3.9%, matching December’s rate, 0.2% more than expected, and still double the Fed’s inflation target. The shelter category, by far the largest weight of the index, rose 0.6% and contributed most to the headline increase, while food prices rose 0.4%, but that was offset by a 0.9% decline in energy prices mostly because of lower gas prices. Used car prices saw another big move lower with a 3.4% decline, followed by a 0.6% decline in apparel and 0.6% decline in medical care commodities. Other areas with larger price increases was medical care services up 0.7% and transportation up 1.0%. As has been the issue, services inflation including or excluding shelter inflation continues to run hot. The index was up 0.7% in the month and still up 4.9% from a year ago.
  • Input prices for businesses rose at a faster pace in January than expected, similar to the consumer inflation report. The producer price index rose 0.3% in the month, more than the 0.1% increase expected. The index excluding food and energy rose 0.5% in the month, also more than the 0.1% expected, and up 0.6% if trade services are excluded on top of that. The headline index is now up 0.9% over the past 12 months while the core index is up 2.0% over the same period, accelerating from December and 0.3% more than expected. Even more, as we know, inflation in services sector is the highest and the index for final demand services rose 0.6% in the month, much higher than expected.
  • The price index for US imports rose 0.8% in January, much higher than expected, with the price index still down 1.3% from a year ago. The increase was driven by a broad range of categories and comes after several months of large declines. The price index for exports rose 0.8% as well, after three months of large declines, with the price index down 2.4% from a year ago. The increase was all broad based, offset by a large decline in agricultural exports.
  • The January retail sales report was a disappointment, with monthly retail sales falling 0.8% versus the expectations for a 0.1% decline. It wasn’t just from the volatile vehicle and gasoline sales categories either, as excluding these two sales were still down 0.5% in the month (versus the 0.2% increase expected). Of the 13 major sales categories, 9 of them saw a decline in the month. Vehicle and gasoline sales both fell 1.7%, building material sales fell 4.1%, miscellaneous store sales fell 3.0%, health/personal care fell 1.1%, while electronics, apparel, and sporting goods sales saw smaller declines. Strength was seen in restaurants and bars with a 0.7% increase, furniture stores with a 1.5% increase, and small increases in grocery and general merchandise stores. Over the past 12 months retail sales are up just 0.6% and up 2.2% excluding gas and vehicle sales. If accounting for the roughly 3.0% inflation rate, real retail sales have declined 2.4% over the past year, raising some red flags for some strategists. January saw a cold stretch, which may explain some of the recent weakness.
  • The Philly Fed manufacturing index was 5.2 for February, an improvement from -10.6 from last month for the first positive readings since August (which was the first positive since 2022). About 27% of firms reported increases in activity, 22% reported decreases, while 45% reported no change in activity in the month.
  • The Empire State manufacturing index was -2.4 for February, ahead of expectations and a large improvement from one of the lowest readings on record in January of -43.7, but still reflecting contracting conditions in the manufacturing sector in the New York region. The pace of input prices and selling prices picked up for the second straight month.
  • US industrial production improved 0.4% in January, driven by a 6.0% increase in utilities which was due to much colder weather in the month (the utilities index is highly weather dependent), but offset by a 0.9% decline in manufacturing, one of the worst in months, and 1.2% decline in mining. Capacity utilization dropped to 78.5% and just below its long-run average.
  • The number of unemployment claims fell 8,000 for the week ended February 10 to 212,000. The four-week average held steady at 218,500. The number of continuing claims increased 30k to 1.895 million with the four-week average up 22k to 1.870 million.
  • The housing market index, an index of home builder sentiment, increased to 48 in February from 44 in January for the best reading since August. The present sales index rose to 52, the expectations for sales over the next six months rose to 60, the best since June, while the index on buyer traffic rose to 33, but still very depressed. A level of 50 is breakeven, with a reading under 50 reflecting less activity/lower sentiment. Sentiment has followed (or lagged by about a month or two) mortgage rates, with rates recently declining from October highs, homebuilder sentiment has improved from near all time lows late 2023.
  • Housing starts for January were a big disappointment – the number of new home construction starts fell 15% in the month to a seasonally adjusted annualized rate of 1.331 million. This is roughly unchanged from a year ago and outside of the 1.305 million reading from August last year, was the lowest level of starts since the massive decline during the pandemic shutdowns. The number of permits authorizing new home builds fell 1.5% to a seasonally adjusted annual rate of 1.470 million. This number has trended around 1.450 to 1.500 million for the past year. While January’s large decline was a big disappointment, we will see next month how this bounces back to see if it was all weather related.
  • The preliminary consumer sentiment survey for February showed sentiment relatively unchanged compared to January. The headline sentiment index was 79.6 for the best since July 2021, even though slightly below expectations. The current conditions index fell slightly to 81.5, while the expectations index increased slightly to 78.4. The expectations on inflation over the next 12 months rose to 3.0% from 2.9% while longer term inflation expectations remains unchanged at 2.9%.

Company News

  • A report by the WSJ said people who have tested Microsoft’s Copilot (its AI assisted software) for six months have said the tool is useful but it does not live up to the price. Companies have said their employees have been eager to try the tool initially, but have found shortcomings and it often makes mistakes. The most problems came from Excel and Powerpoint while the least were from Teams. On the other hand, Microsoft has recently said demand has been unprecedented and those testing it have found it valuable.
  • WSJ reported Walmart is in talks to buy the TV maker Vizio for more than $2 billion. The deal would represent about a 27% premium to where shares traded prior to the report. Walmart has been Vizio’s largest customer. The report said talks are still ongoing and no agreement has been made and a deal could still possibly fall apart. The purpose for the acquisition would be to help grow Walmart’s advertising revenue, not necessary to sell more TVs. Vizio TVs would provide Walmart with data on its viewership and advertising revenue through its operating system, similar to how Roku makes money. Roku shares were down on the news.
  • Uber shares traded nearly 10% higher after it announced its first ever share buyback program of $7 billion. This comes after a very strong earnings report from last week. In addition, it provided a three year outlook, setting a goal of profitability expansion, expecting gross bookings to grow mid- to high-teens and EBITDA growth of high 30s to 40% range.
  • OpenAI, creator of Chat GPT and a major partner with Microsoft in its AI efforts, is reportedly working on a web based search product, which may be partly powered by Microsoft’s Bing search platform, according to The Information. This would put it in direct competition with Alphabet’s Google search, whose share were down about 3% after the news. The report said it was not clear if the potentially new search would be part of or separate from its ChatGPT tool. In separate but related news, it said it is launching a video generation model called Sora. The AI assisted model will create video scenes from text instructions.
  • Target introduced a new private label brand “Dealworthy” that targets the low cost shopper and is similar to a dollar store model where most items will be priced under $10, including everyday household items. Most items will be priced 50% lower than other similar branded items sold at the stores.
  • The private equity group Roark Capital, also the owner of Inspire Brands – owner of fast food chains, is reportedly in the early stages of considering taking the company public via an initial public offering, according to Bloomberg. Inspire Brands was created in 2018 as the owner, operator and franchisor of restaurant brands including Dunkin’ Donuts, Arby’s, Jimmy John’s, and Buffalo Wild Wings, among others. It has held discussions for an IPO in late 2024 or 2025, depending on market conditions, and says Inspire Brands could be valued around $20 billion. One of Roark’s most recent acquisitions was Subway for $9.6 billion in 2023.
  • After rumors of a deal over the weekend, late Monday evening, Capital One confirmed it has agreed to acquire global payment network Discover Financial in an all stock deal that values Discover at $35.3 billion, representing about a 25% premium to where shares traded prior to the announcement. Capital One said the deal is expected to generate $2.7 billion in pretax synergies and add 15% to its earnings by 2027. The terms of the deal say Discover shareholders will receive 1.0192 shares of Capital One for each Discover share owned. Discover was the smallest of the four major U.S. based global payment networks (Visa, Mastercard, and American Express).

Other News

  • Bank of America’s monthly Global Fund Manager Survey for February showed that global growth expectations reached the highest level in two years. It showed investors are predicting no recession for the first time in two years, a sharp reversal from where expectations stood at this point last year. Equity allocations are the highest in two years while US equity allocations are the highest since late 2021 with tech the highest since mid-2020. Inflation remains the biggest risk but just 7% expect inflation to accelerate moving forward.

The Week Ahead

Earnings season continues to roll on this week with focus shifting to the retail sector with companies like Home Depot and Walmart reporting quarterly results followed by another large wave of retailers next week. However, the most anticipated quarterly report will come from Nvidia which reports on Wednesday. Investors will be looking for if its guidance is raised up to expectations. Other quarterly results come from Medtronic, Palo Alto Networks on Tuesday, Etsy, Analog Devices on Wednesday, Intuit, Keurig, Moderna, Block on Thursday, and Warner Bros. Discovery on Friday. On the Fed side, the FOMC will release its meeting minutes from the January meeting on Wednesday where markets will look at how much detail policymakers talked about when it comes to rate cuts this year. There will be more Fed speak this week with the busiest day Thursday when at least five Fed policymakers are expected to give public appearances. It will be a very light week of economic data – Thursday is the only day we see any data releases with jobless claims and existing home sales released in the morning.