Smart Macro: Back to Higher for Longer

February 16, 2024 – Financial Sense Wealth Management CIO Chris Puplava discusses two leading indicators for inflation that are now starting to rise, raising concerns that interest rates may need to stay higher for longer than Wall Street originally anticipated. Chris also discusses the important shift we are seeing with consumer spending behavior and his broader outlook for the US economy.

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Transcript:

Cris Sheridan:
[00:00:00 - 00:00:30]
Well, we've seen a couple of inflation reports, prized to the upside beating economist expectations. A lot of concern now being raised in the financial media and by investors as to whether or not we are going to see a reacceleration in the inflation outlook. Of course, that means interest rates are also ticking back up. And this is pushing off the possibility of near term Fed rate cuts out to May or June, with some analysts even saying that Fed rate cuts may get pushed off to the second half of this year. So lots of things that are in flux. And joining us today to speak about this is Chris Puplava, CIO of financial sense wealth management. So, Chris, let's talk about the inflation trends that we're looking at. We saw a hotter than expected producer price index and also CPI, the consumer price index. So both on the producer side and on the consumer side, seeing inflation pick up a little bit. How concerned are you about this?

Chris Puplava:
[00:00:52 - 00:01:16]
Well, I think everyone should be concerned. The Fed, investors, consumers. Here's the problem is we had all this money created, we pushed it into the system, and it hasn't contracted. So yes, inflation is not at 9% like it was in 2022, but it's also not negative, meaning we haven't seen a decline in prices. We've just seen a moderation in their escalation.

Chris Puplava:
[00:01:16 - 00:01:40]
But, oh, my gosh, no matter what you look at grocery bills, utility bills, here in Arizona, where I live, I just got a 50% increase in my water bill. Wow, that's quite a shocker. They're warning there may be more to come. And unfortunately, part of that is just, I'm in Arizona and you've got California, which gets kind of an unfair share of Colorado river water. So they don't take cuts.

Chris Puplava:
[00:01:40 - 00:02:05]
Arizona, Nevada, New Mexico and others do. So that's part of his politics. But still, that's a huge increase. And for the market last year, we had a declining trend in inflation, and there was communication from the Fed that they were getting close to being done with raising rates. So the next progression from that is essentially rate cuts.

Chris Puplava:
[00:02:05 - 00:02:38]
And the market was priced in a fair amount of rate cuts, I think at 1.4 rate cuts or four quarter point cuts, a total of a two percentage point drop in the federal funds rate. And unfortunately, the data has not corroborated that trend of falling to inflation. I mean, even if you look at the CPI, it's more or less stabilized since last summer. I mean, we've been pretty stable at roughly a 3% annual inflation rate. But there's leading indicators of inflation that are starting to hook up that do pose some concern.

Chris Puplava:
[00:02:38 - 00:03:25]
And we've got a lot of those recently, in the past two weeks since we last spoke, one of them being the IC manufacturing report, the prices paid index that now is back into expansionary territory at 53. The one that really kind of shocked was the prices paid for the servicing PMI that jumped all the way to 64. So that's a huge jump in terms of expansionary territory. And those tend to lead, when you look at a historical relationship, anywhere from three to possibly six months, the overall consumer price index. So it's arguing that the trough is in that we're not getting a 2%, which is what the Fed wants, that we may actually be accelerating back up to a three and a half, 4% inflation rate.

Chris Puplava:
[00:03:25 - 00:03:48]
It's not just coming from the Ism. There's other things that I look at. For example, the National Federation of Independent Business or Small Business NFIB, they've got an index in terms of the respondents plans to raise prices in the next three months. That's currently at 33. And previously that hit a low of, I believe in the low 20s, but that bottomed back in October of last year.

Chris Puplava:
[00:03:48 - 00:03:58]
And it's been in a rising trend. And corroborating that is, I'm sure listeners may or may not have heard of Dr. Copper or Dr. Cosby. Dr.

Chris Puplava:
[00:03:59 - 00:04:20]
Copper is basically saying that copper has a phd in economics, meaning you tend to see copper and collect just before major economic turning points. So it heads down before recession and a heads up before an expansion. And the other one that people give a phd to is the Dr. Cosby or the korean stock index. The index.

Chris Puplava:
[00:04:20 - 00:04:45]
And because Korea has a huge export economy, you look at the US, we're a consumption based economy. Korea is an export economy. You've got Samsung, I mean, obviously a huge exporter of semiconductors and finished technology products, appliances, cars. You've got Kia and so forth. So when you look at the activity or export activity of Korea, it can kind of give you a good sense of the global economy.

Chris Puplava:
[00:04:45 - 00:05:30]
And when you look at korean exports, they are up 18% year over year, and they've been inflecting sharply higher. Those tend to lead the US inflation, commodity prices in general, by about three to six months as well. At one point, they hit a low of roughly around negative twelve, negative 15% year over year last late summer to early fall, and they've been heading sharply higher since. So there's a lot of data out there corroborating that the inflation rate may have bottomed. Now one of the big ones that's going to be continually weighing on inflation, and there's owners equivalent rent, and that's because that lags actual housing appreciation with a significant lag.

Chris Puplava:
[00:05:30 - 00:05:54]
We all know housing prices year over year have been declining for quite some time. So if you strip that out, inflation is actually quite sticky and is heading up. I mean, you look at insurance costs. One of the ones that stood out for me on the CPI report, Chris, was insurance premiums. Those are up anywhere from 20% to 24%, which was kind of odd to me, but I was reading into it.

Chris Puplava:
[00:05:54 - 00:06:17]
I guess part of that reason is litigation costs, that the cost of lawsuits has gone up. So the size and the number of lawsuits related to accidents have picked up, forcing insurers to pay out even more. And they're just doing what businesses do, they're passing that right on to the consumer. So there is a lot of inflation still, I think, in the pipeline. That didn't really go away, it just moderated.

Chris Puplava:
[00:06:17 - 00:06:35]
That's going to have major implications for financial assets. I mean, we've already seen interest rates here in the US start to head up sharply higher. Mortgage rates are moving back up. There was some signs of life in housing that could put a kibosh to that. And when you look at the bond market, it was pretty rough.

Chris Puplava:
[00:06:35 - 00:06:54]
A lot of people were getting very excited. A lot of cios were talking about extending the maturity of their bond portfolio by long term us treasuries. But I'm looking, Chris, at a 30 year treasury. It's down five and a half percent year to date. A ten year treasury is down 2.8% and the bond benchmark is down about two and a quarter.

Chris Puplava:
[00:06:54 - 00:07:09]
So bonds so far this year are losing proposition. The stock market is still doing well. I mean, obviously it's being powered by tech. The SP is up 5.4, but if you look at the SP, equal weight, it's only up two. The Dow is up just under three.

Chris Puplava:
[00:07:09 - 00:07:33]
So a little bit muted. But the concern I have is this trend. If it continues these leading inflation indicators, it does argue that inflation for the CPI and PPI are likely to head higher. And the mantra won't be about, or the discussions won't be about rate cuts, it's going to be back to deja vu. It's going to be 2023 all over again, where Powell was saying higher for longer.

Chris Puplava:
[00:07:33 - 00:07:36]
And I don't think the markets are primed for that.

Cris Sheridan:
[00:07:36 - 00:08:15]
Yeah, and really the message that we've been having here on financial sense ever since COVID was that we were expecting a prolonged period of higher inflation. And at this point, like you noted, we have moderated considerably from the peak that we saw in 2022. But the question is whether or not we're going to be sticking more around this three to 4%, or getting as high as 5%, or going back to the Fed's goal of 2%. And I think from a lot of what our guests have been saying on the show, we could get down to that 2% range again. But that's likely going to happen in the context of further economic weakness.

Cris Sheridan:
[00:08:15 - 00:08:35]
However, if we do see the economy continue to accelerate, which we have seen at the beginning of this year so far, then that's going to keep inflation at that stickier level. So we probably would be looking again with the three handle on the CPI, if not as high as 5%, if things do start to heat up even more.

Chris Puplava:
[00:08:35 - 00:09:10]
That's true, Chris, and this kind of coupled with that is a concern about the soft versus hard landing debate. The reason why that's important is if inflation heats up and we get more towards a hard mean, we're talking stagflation. I mean, that is the worst case scenario where, especially for the Fed, where if the economy is slowing, the Fed would want to ease, but if inflation is rising, they're just going to contribute to inflationary pressures. So that is a really negative environment that's going to smell a lot more like what we saw in the 1970s. I mean, at least early coming out of COVID Yes, we had inflation, but we also had strong growth.

Chris Puplava:
[00:09:10 - 00:09:42]
So if we see weak growth amidst strong inflation, that is not a good recipe for either stocks or bonds. Default risk will go up, which will hurt corporate bonds and so forth. Obviously, just the move higher in inflation will likely pressure interest rates higher, hurting all types of bonds, and then the weak growth is going to be a hit to corporate earnings. So that could also be a negative for the stock market. So watching that is going to be still a huge importance going forward.

Chris Puplava:
[00:09:42 - 00:10:11]
So far, the data has been decent kind of hit and miss. We had a decent jobs report for January, but this week we got a pretty dismal retail sales report, came in below expectations. That kind of lines up, Chris, with what I'm seeing in terms of foot traffic. For example, when I pull up Ross stores, a discounter, Bloomberg has a kind of comparables as well. Looking at other companies like Ollie's, Bargain Outlet, Burlington stores, TJ, Maxx, so off price retailers.

Chris Puplava:
[00:10:11 - 00:10:45]
And what I could see going back three years was year over year. They actually had declining foot traffic in 22 and 21. And that's, I think a lot of it had to do with people getting stimulus checks and shopping at higher end retailers. But starting in January, or actually, really, it was December of 22, I started to see negative year over year monthly declines turning into positive. So in December of 22, we flipped to a positive year over year growth in store traffic for these off price retailers, and that persisted throughout 2023.

Chris Puplava:
[00:10:45 - 00:11:25]
I'm talking double digit growth in store traffic for these discounters. And now what I'm noticing, 24 is rather than the sharp growth rates of anywhere from ten to 15% year over year, it's moderating, Chris, now to single digits in January of 2024 of this year. And when I compare that to, for example, Nordstrom's, I mean, let me just give you some of the numbers to show you how eye opening they are. In May of 21, Nordstrom's footstore traffic was up 972%. I mean, obviously, I'm comparing to almost the peak of the lockdowns, but still go to November of 2021 versus November of 2020.

Chris Puplava:
[00:11:26 - 00:11:53]
Store traffic was up 62% for Nordstrom's. And then when we get into 22 in the first quarter, Nordstrom's was still seeing anywhere from 20% to 40%. Year over year growth in store traffic, however, cut off those stimulus checks, and then the traffic fell off a cliff. So let me give you an example of that. In April of 2022, the year over year traffic, foot traffic for Nordstrom's, was 22%.

Chris Puplava:
[00:11:53 - 00:12:13]
Fast forward two months to June of 22. It's negative one. So completely reversed. And when we look at that, it continued to actually accelerate. So that when we were in February of 23, so last year, we're starting to see now double digit decline rates for traffic to Nordstrom's, Dillard's, Macy's, Kohl's.

Chris Puplava:
[00:12:13 - 00:12:41]
And unfortunately, Chris, for those retailers, that's continued into January of this year. For example, Nordstrom's, same store traffic was down about 4%. But you go to Dillard's, down twelve, Macy's, 16%. Cole's store traffic is down 17%. So we are seeing, Chris, a persistence in moving away from the higher end retailers to the off price, low cost retailers, dollar stores and the like.

Chris Puplava:
[00:12:41 - 00:13:03]
So you're seeing the shift in spending patterns by the consumer. What we're also starting to see, Chris, is the same in terms of restaurants, restaurant sales, and foot traffic are starting to go down. So it's clear that the consumer is being pinched. And one of the things that we see in here almost on a daily basis. And we saw a couple of announcements.

Chris Puplava:
[00:13:03 - 00:13:48]
I believe Cisco announced a 5% cut to their workforce is, I'm not hearing, Chris, anyone coming out announcing a 5% jump in their workforce in terms of hiring. All you're hearing about is layoffs. So it does kind of put to question the validity of those non farm payrolls, given we're seeing actual changing trends and patterns in the consumer in terms of where they're shopping and how much they're shopping. So this is going to be a really precarious position, Chris, for the stock market, particularly at all time highs. The SP over 5000 is, if this happens, where we do end up slipping into a recession, mild or not, at the same time, inflation is picking up.

Chris Puplava:
[00:13:48 - 00:14:16]
That could be a very nasty picture for the stock market. So again, Chris, all options are on the table. We may see an acceleration in the economy, but it's the reason why we're not pedals to the metal in a sense of taking maximum risk. We're neutral to slightly underweight stocks at this moment. And as I've mentioned many times, keeping an eye on that exit door, because if we do kind of have a stagflationary environment, it could get really ugly for stocks going forward.

Chris Puplava:
[00:14:16 - 00:14:21]
So really important to keep an eye on the exit and constantly on the data.

Cris Sheridan:
[00:14:21 - 00:15:13]
Yeah, that was one thing that Jim Bianco had said on our show recently, is that the main story here comes down to inflation and interest rates. Right? So if we do start to see, like you said, these leading indicators for inflation end up accurately signaling a pickup three to six months down the road or a sustained uptrend in inflation from current levels, then that is going to be putting more pressure on the Fed to either stay pat or conversely, even raise rates, which Larry summers actually just came out and said, but if inflation does pick up from here, then of course, borrowing costs will go up, interest rates are going to go up, and that is a loss or a drain of liquidity to the system. And of course, that also raises some of the larger concerns when we think about commercial real estate, which there's been some more rumblings about that as well. So a number of things, like you said, that are going to be key to watch.

Cris Sheridan:
[00:15:13 - 00:15:39]
And I know that you do have your finger on the pulse of a lot of these leading indicators when it comes to inflation, interest rates and the economy. So with that said, if any of you listening would like to get in contact with us and speak with Chris or the rest of our investment team about how we can assist you feel free to give us a call at 888-486-3939 or go to our website financialsensewealth.com. Chris, always a pleasure to get an update from you. Look forward to speaking with you in another two weeks.

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