Sticky Prices

Despite being well below its 2022 peak, inflation remains troublesome for the Federal Reserve and, by extension, markets. Stocks are retreating following a third consecutive month of a stronger-than-expected Consumer Price Index (CPI) report. This string of surprises has investors questioning the likelihood and timing of rate cuts in 2024.

The good news is that despite sticky prices and interest rates, the economy remains strong, bolstered by powerful tailwinds. Unemployment sits near historic lows, consumers continue to spend at a healthy rate, and AI has serious potential to increase productivity. Though there may be short-term speed bumps, it is essential not to lose sight of the bigger picture.

In March, CPI increased 3.5% year-over-year vs. economists’ expectations for 3.4%. Excluding volatile food and energy prices, core CPI increased 3.8% vs. economists’ expectations of 3.7%. Diving deeper into the numbers, we see that shelter and services continue to be the driving force behind the sticky prices. Shelter costs increased 0.4% month-over-month and 5.7% year-over-year, raising questions about the long-anticipated easing of rents. On the services front, there were notable increases in motor vehicle maintenance and repair as well as motor vehicle insurance.

Though goods inflation has subsided, we continue to grapple with problems stemming from a structural shortage of housing and labor. However, these issues are generally outside of the Fed’s purview that could keep inflation from reaching the 2% target. Although goods inflation remains stable, there are still concerns about the impact of geopolitical events. Escalating conflict between Israel and Iran has pushed crude prices meaningfully higher over the last several weeks. Further confrontation between the two runs the risk of an even greater surge in commodity prices. Markets are keeping a close watch.

While inflation may be stubborn, we will unlikely see a return to post-pandemic inflation levels of over 6%. Instead, inflation may be settling into a new normal, a range somewhere between 2% and 4%. We do not expect that these levels will be fatal to stocks, but some will fare better than others in this environment. In particular, growth stocks offer defensive qualities against inflation. Companies that execute long-term growth plans will continue to be rewarded. In addition, we could see a resurgence in stocks that typically benefit from inflation after underperforming for most of 2023. Conversely, companies facing significant input costs and a lack of pricing power could struggle.

Thanks,
Preston May, CBE®
Research Analyst