Weighing the January CPI’s Inflation ‘Disappointment’

Stocks sink on higher-than-expected inflation, fading hopes for Fed rate cuts. So blared headlines Tuesday. To many, it is axiomatic that stocks hinge on the Fed, and the Fed hinges on slight consumer price index (CPI) wiggles—an obsession leading the world to sweat the very, very small stuff. As an antidote, we suggest looking at this the way stocks do when they are acting as weighing machines rather than day-to-day voting machines: Consider how much this truly matters to corporate earnings over the next 3 – 30 months.

We know Tuesday’s volatility says otherwise. Seeing the S&P 500’s biggest down day in a while follow an inflation report everyone called disappointing because January headline prices slowed to 3.1% y/y versus an expected 2.9% on a month-over-month uptick can reinforce notions of a strong link between them.^[i] But heat-of-the-moment reactions like this often aren’t real. Maybe it really is a disappointing bit of news knocking the wind out of stocks—in which case, fine, these things pass quickly. Or maybe it is just that a bunch of traders had certain buy/sell triggers programmed in and executed those trades, which triggered more trades, which then triggered still more trades, and the tug of war over whether this is a buying day or a selling day netted out to something irrational and detached from reality. The maddening, frustrating thing is that the conclusion to this dilemma is nearly always, who knows.

So yes, we get the frustration. Which is why we share with you the best darned way we know to navigate it: Rise above and look longer term. On any given day, stocks will do what they do based on millions of trading decisions made for different reasons, with different time horizons in mind. Feelings and biases tend to float to the top—feelings about the future and biases about what technical indicators allegedly mean stocks will do over the next five seconds (or five minutes, five hours, five days, or, or, or). It is all noise and static. But over a more meaningful timeframe, all the noise cancels itself out, and stocks’ dynamite tendency to weigh the likely economic reality moves to the forefront. This underpins the wisdom of Ben Graham’s legendary description of the market being a voting machine in the short term and a weighing machine in the long term. It is right, in our view, and the framing is a sanity lifeline.

Accordingly, let us view the inflation conversation in this light. The consensus is that because CPI slowed less than expected—and because allegedly stickier services prices bore much of the responsibility—investors pushed out their rate cut expectations from May to June, and this sank stocks because the rally rests on the prospect of rate cuts. Whatever you think of rate-cut timing, the latter part of that assertion is dubious. The bull market began in October 2022, when the Fed was hiking at a steep pace and no one seemed capable of even dreaming of rate cuts, never mind projecting when they would arrive. Since then, stocks have moved ahead of better-than-expected US economic growth and the corporate earnings recovery data now reflect. These are all fundamental bedrocks for a sustained market rally, far firmer footing than flimsy hopes about one Fed-controlled interest rate.

But even if rate cuts were the swing factor here, ask yourself: What in the world does it matter to corporate earnings in the balance of this year and 2025 if the Fed makes its first rate cut in May, June, July, September or even later? (Not that there is really any hint here what the Fed may do, because no one knows how that cabal of people will interpret these or other data.) Even at higher rates, business investment is rising, and capital markets are allocating capital to growing firms. If high rates aren’t deterring this vital economic activity, then how does it make sense to argue stocks absolutely need a rate cut in May to justify higher valuations? Any planned investment that depends on rates being a tad lower is marginal, and businesses probably won’t make it regardless. There are simply far more—and more powerful—forces affecting businesses’ planning and consumer demand than whether the Fed starts nudging borrowing costs down in spring, summer or autumn 2024. Especially when we already have a great deal of evidence—courtesy of rock-bottom bank deposit costs—that Fed rate hikes didn’t much impact the real-world cost of money anyway.

Maybe stocks didn’t appear to look past CPI and rate chatter Tuesday. Sometimes that happens. But that doesn’t mean you should obsess over it, especially when the data didn’t show anything in the way of meaningful changes. One big driver was shelter prices, which have been among the most stubborn—and which tend to lag real life by about a year and a half due to the way CPI is calculated. There is a big backlog of multifamily housing units under construction and about to come online, and this should help continue taming housing costs as time passes. Meanwhile, anemic money supply suggests we shouldn’t have a resurgence of too much money chasing too few goods and services, which is what it would take to jumpstart inflation anew. Don’t fight the last war.