Bob’s Journal for 2/22/2024

What the Key Inflation Indicators Are Saying

Consumer price inflation is at or near the Fed’s target. Or is it?

Economists and analysts debate the best way to measure inflation and argue over its true level. 

It is an important discussion today because investors’ inflation expectations fuel changes in interest rates and prices of stocks and bonds. 

Most agree the widely followed Consumer Price Index (CPI) isn’t a good measure of inflation. Among other problems, it gives too much weight to housing and measures housing inflation in a peculiar way.

For a long time, Fed officials have said the Personal Consumption Expenditure (PCE) Price Index is better and the measure they focus on more than the CPI. It gives less weight to housing and measures housing inflation in a different way, among other improvements.

Even better is the PCE excluding food and energy, also known as the core PCE Price Index.

Economists like to exclude food and energy because those prices are volatile, and the goods are essential. If their prices spike, people still buy the items. They’ll forego other purchases when food and energy inflation is high. In the short run, food and energy price increases can distort general price inflation measures. 

Fed Chairman Jerome Powell is said to prefer the PCE excluding food, energy, and housing. It avoids the three controversial items and focuses on price inflation in the rest of the consumer shopping basket, which are considered the core consumer goods and services. 

By this measure, inflation has been declining fairly steadily since February 2022 (when it peaked at 5.88% over 12 months) and very steadily since September 2022. In the most recent report, by this measure, inflation over the last 12 months was 2.16%.

But the economists at the Cleveland Fed, with help from Ohio State University, developed a measure they call the Median Consumer Price Index.

They say this index is a better measure of core inflation trends. It excludes the 49.5% of the CPI components with the highest and lowest price increases over the last month.

The index’s supporters say it has shown to be a better signal of inflation trends than the other indexes. Notice they don’t say it is a better measure of actual consumer inflation but that it does a better job of showing emerging trends. It lets policymakers know when core inflation is changing direction. 

The Cleveland Fed recommends looking at the recent percentage change at an annual rate of the Median Consumer Price Index.

By that measure, inflation remained high through 2022 and peaked in February 2023 at 7.88%, well after the other inflation measures peaked.

But it hit a low in July 2023 at 2.49% and steadily rose. Most recently, it was 6.54%.

If the Median CPI is right, the other inflation indexes soon should rise.

What You Should Know About the History of Concentrated Stock Index Returns

The S&P 500 and other major stock indexes are concentrated more and more in a very few stocks and sectors. 

That could make this a dangerous time for index investors, according to research from investment management firm GMO.

Researchers Ben Inker and John Pease point out that the seven largest capitalization companies now make up 28% of the S&P 500. That’s at or near a record, as has been the case for the last year or so. The concentration is the result of the largest capitalization companies becoming bigger by continuing to outperform the rest of the market.

The concentration has hurt many investors who use non-index investment managers. In the decade ending with 2023, 90.2% of mutual funds that invest in U.S. large capitalization stocks underperformed their benchmarks, according to Morningstar data cited by the GMO report. More than 74% underperformed in 2023.

GMO indicated that the concentration should be a warning to investors. The concentration of the indexes and the sustained outperformance of a few large companies are unusual.

Since 1957, the 10 largest capitalization stocks have underperformed the indexes. On average since then, nine of the 10 largest capitalization stocks trail the index.

Also, since 1957, the 10 largest stocks have underperformed the equal-weighted S&P 500 Index by 2.4% per year. 

Yet, since 2013, the 10 largest stocks outperformed the equal-weighted index by 4.9% per year.

GMO indicated part of the reason for the recent outperformance by the largest stocks is that many of them started the decade substantially undervalued relative to the index. The increased valuation of the companies accounted for a large part of their outperformance.

The companies’ economic performance also was quite good during the last 10 years. Several reinvented themselves while others had high earnings growth by increasing their domination of their industries.

Index investors and others with big holdings in the largest stocks need to decide if they expect these stocks to maintain their high valuations, earnings growth and dominance of their industries.

If the companies stumble or investors decide they aren’t worth current valuations, concentrated investors will be hurt. They’ll also be hurt if markets return to their average historic balance between the largest stocks and the rest of the market.

How Interest Rates and the Economy Affect Annuity Payouts 

Annuities and guaranteed lifetime income are surging in popularity, yet many people remain on the sidelines.

The aging of the Baby Boom generation, economic and market uncertainty and higher interest rates combine to spur the interest in annuities.

A lot of people still don’t pull the trigger on annuity purchases because they wonder if they should wait for higher interest rates or a change in the economy.

Interest rates and the economy don’t have significant effects on the annuities that pay guaranteed lifetime income.

The yield on a multi-year guaranteed annuity (MYGA) will change as market interest rates change. After you deposit money in a MYGA, most adjust their yield every 12 months. When you’re looking to acquire an annuity, most insurers change the rate guaranteed for the first year every seven to 10 days. 

Keep in mind that insurers look at longer-term rates, such as the yield on the 10-year treasury bond. They don’t care much about short-term rates and whether the Fed plans to change the federal funds rate at its next meeting or the one after that.

But for annuities that pay guaranteed lifetime income, interest rates are a secondary factor.

Sure, a single-premium immediate annuity purchased today will pay higher lifetime income than one purchased three years ago, because interest rates are higher and are expected to remain higher than three years ago.

But it takes a big change in interest rate expectations to make a significant change in a SPIA’s lifetime income payout. 

The primary factor in the income paid on such annuities is your life expectancy. The age at which you buy the annuity is the key determinant of the income you’ll receive. The older you are, the higher the payout will be.

If you wait until interest rates rise to a level you want, you miss the annuity payments that would have been received had you purchased the annuity earlier. You must put your money somewhere while waiting to buy the annuity, so you’re either taking a market risk or the money is in low-yielding investments to keep it safe.

When you’re looking for guaranteed lifetime income, you shouldn’t try to time the annuity purchase based on interest rates or expectations for rates. Either it is the right time in your life to lock in guaranteed lifetime income or it’s not.

You maximize your guaranteed income not by timing the purchase with interest rates. You maximize the income by shopping among all insurers instead of considering proposals from only one or two companies.

As with other investment and financial decisions, you’re unlikely to be able to pick the ideal time to buy with the best possible interest rates.

The Data

The Leading Economic Indicators Index from The Conference Board declined 0.4% in January, following a 0.2% fall in December.

The index declined 3.0% over the last six months, which is an improvement from the 4.1% decline in the last six months.

The good news is that for the first time in the past two years, six of the 10 indicators in the index were positive. The Conference Board said this means the index no longer is signaling a recession in 2024. But it does indicate economic growth will be near 0% in the second and third quarters of the year.

The Empire State Manufacturing Index improved to negative 2.4 in February from negative 43.7 in January. While that’s a substantial improvement, the negative number still indicates the sector contracted.

The Philadelphia Fed Manufacturing Index in February was 5.2, up from negative 10.6 in January. That’s the first positive number for this index since August.

Retail sales declined 0.8% in January, the largest monthly decrease since March 2023, after rising 0.4% in December.

Excluding vehicles and gasoline, retail sales declined 0.5% in January after increasing 0.6% in December.

Over 12 months, retail sales increased 0.6% through January. That’s the lowest 12-month increase since May 2020. 

Industrial production declined 0.1% in January after being unchanged in December. Manufacturing production declined 0.5% in January, following a 0.1% increase in December.

Over 12 months, industrial production was unchanged through January. It was up 1.2% through December.

Manufacturing production declined 0.9% over the 12 months ending in January after being up 1.3% through December.

Home builders were a little more optimistic in February. The Housing Market Index from NAHB was 48, up from 44 in January.

That’s the third consecutive month the index improved after bottoming at 34 in November.

The Producer Price Index (PPI) increased 0.3% in January after falling 0.1% in December. The core PPI, which excludes food and energy, increased 0.5% in January, up from a 0.1% decline in December.

Over 12 months, the PPI increased 0.9% through January and the core PPI rose 2.0%.

The Consumer Sentiment Index from the University of Michigan increased slightly in the first half of February. The index was 79.6, compared to 79 at the end of January. 

New unemployment claims declined by 8,000 to 212,000 in the latest week.

Continuing claims, which lag a week behind new claims, increased to 1.895 million from 1.865 million.

The Markets

The S&P 500 rose 0.54% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.91%. The Russell 2000 increased 2.19%. The All-Country World Index (excluding U.S. stocks) added 2.80%. Emerging market equities advanced 2.55%.

Long-term treasuries gained 0.53% for the week. Investment-grade bonds increased 0.80%. Treasury Inflation-Protected Securities (TIPS) added 0.49%. High-yield bonds rose 0.65%.

On the currency front, the U.S. dollar declined 0.67%.

Energy-based commodities fell 0.38%. Broader-based commodities lost 0.24%. However, gold rose 1.65%.

Bob’s News & Updates

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