Some Pain is Back

February 23, 2023


  • The U.S. CPI report for January showed that inflation had decreased for the seventh consecutive month, but still exceeded expectations, with shelter costs being the primary contributor to the increase.
  • While some data suggests that inflation may be slowing, it remains a concern for the market because it is still too high for the Federal Reserve's liking.
  • Increased job growth in the United States, combined with low jobless claims, has pushed the peak Federal Funds rate higher. As a result of higher interest rates, U.S. Treasury bond yields increased and bond returns were mostly wiped out.
  • Profitability and margins for large US corporations are being impacted by the global economic slowdown. However, current earnings estimates indicate a smaller year-over-year drop in earnings than market forecasters previously predicted, which could potentially lead to better stock market performance if forecasts hold up.

February Review

It may be the shortest month of the year, but after multiple asset classes retrenched, February is seeming like a long drawn-out month. Like most months, a slug of economic data comes out every week and markets react.

The report on U.S. CPI data for January didn't bring fruitful news, and it wasn't a pleasant surprise for Valentine's Day. While the report showed that inflation had decreased for the seventh consecutive month, it was still higher than expected by most economists. This report confirms that the risk of inflation is still present, and the market certainly does not believe that we are completely immune to its effects.

When delving deeper into the drivers of inflation, it appears that energy prices are cooling, but shelter was by far the largest contributor to the monthly advance, accounting for nearly half of the increase.1 Shelter costs represent roughly one-third of the overall CPI index, and there is a significant lag between real-time price changes and government statistics due to the way housing metrics are calculated.

Jeremy Siegel, a well-known economic expert and author of the investment classic Stocks for the Long Run, noted that if current housing prices from Zillow rental indexes and the Case Shiller Home Prices Index are substituted into the Consumer Price Index (CPI), the Core CPI now has four consecutive months of negative inflation prints. Although this is encouraging news, it does not change the fact that inflation is far too high.

The Federal Reserve is aware of the lagging effects of the housing data, and has its eye on Core Services ex-Shelter to gauge the direction of inflation. This measure of inflation rose 0.3% in January, a slight easing from the prior month, according to Bloomberg.

Beyond inflation data, jobless claims, generally thought of as a leading indicator of the economy, haven’t trended higher despite weaker manufacturing data and soft housing starts.

Elevated job gains, combined with other data releases and some of the Fed’s own rhetoric, has been a recipe for an increase in the peak Federal Funds rate. The peak interest rate has moved up by nearly 0.50% during this month to 5.36%.

In a nutshell, this is not what market participants were hoping to see, and it’s no wonder that this re-assessment has radiated across other markets. For example, as we write this, the 10-year Treasury bond yield has risen to 3.9%, up from the low of 3.37% on January 18th of this year. The return for the Bloomberg U.S. Aggregate Bond Index has nearly been completely wiped out as a result of the increase in yields. Furthermore, the S&P 500 Index has lost roughly half of its gains for the calendar year, and emerging market stocks, as represented by the MSCI EM NR Index, have fallen from double digit gains to low-to-mid single digit gains.

Turning to earnings, as more than 90% of large cap companies in the United States have completed their reporting season, it has become clear that the global economic slowdown and high inflation are having an impact on profitability. Margins have been particularly weak, as both net income and operating margins are on pace to miss expectations for this quarter. However, despite the fact that earnings per share growth for the quarter turned into negative territory, it is still on pace to come in slightly better than the preseason forecast, at -2.1% vs. -3.3%.2

The most pessimistic forecasters predicted a 15% to 20% drop in earnings for the full year 2023, but current estimates suggest only a 1.13% year-over-year drop in earnings. Should earnings forecasts hold up throughout the year, investors may relax and the stock market may perform better than expected.

  1. Pickert, R. (2023, February 14). ‘U.S. Inflation Stays Elevated, Adding Pressure for More Fed Hikes”.
  2. Bloomberg.

´╗┐Important Disclaimers and Disclosures