The Week Behind

The bull thesis continued to pick up steam. CPI came in as expected, marking the third consecutive MoM decrease in core inflation. Alongside December Payrolls showing wage-inflation may be rolling-over, the data is making a case for the Fed to only hike 25 bps at their next meeting, which would be bullish for markets. As yields and the dollar continued incrementally lower, the magnitude and breadth of the rally widened to include even speculative parts of the market. For the week, the DOW added 2%; S&P tacked on 2.67%; and the NASDAQ expanded 4.82%.    

Highlights

• Powell did not go out of his way on Tuesday in Sweden to sound incrementally hawkish as he has in previous speeches. 
• Headline CPI printed 6.5%: in-line with consensus and lower than last month’s 7.1%; Core CPI printed 5.7%: in-line with consensus and lower than last month’s 6.0%.

Does December CPI Make For A Less Volatile 2023?

Over the last 6-12 months, influential economic releases – especially CPI, PCE, and Payrolls – have often felt binary. A bad number, stocks get buried. A good number, stocks launch to Mars. While these releases were, are, and will continue to be important, I think the volatility and anticipation placed on these releases will start to diminish meaningfully moving forward. 

Why? Since late-November, a few variables affecting the macroeconomy have materially changed. Most recently, December CPI may have solidified a new degree of analyst credibility.

For most of last year, there was an abundance of uncertainty surrounding the peak and stubbornness of inflation and interest rates. Questions continued to mount concerning the strength and resilience of corporate and household balance sheets. Recently, much of that uncertainty has abated. We can say with confidence inflation has peaked. We know which components are most stubborn. We have a more concrete idea of the terminal rate. Corporate balance sheets have remained healthy. Earnings reports from consumer-facing companies show households continue to spend but in a more conscientious manner. Simply put, data over the last 2-3 months has provided us with more certainty now in early-2023 than we ever had in 2022. More certainty means less volatility. 

As for December CPI, it marks the first time since December 2021 analysts accurately predicted core. March 2022 was the last time analysts nailed the headline. During 2022, there was a stretch where the only certainty was that analyst projections would be wrong. However, analysts’ relative success over the past number of months has changed the way we approach these events. This revival of analyst credibility better enables institutional money managers to put long-term money to work. It also implies less surprise in economic releases. Both are constructive for less volatile and more investable (as opposed to tradable) markets.  

The Week Ahead

We will start the shortened trading week with another round of bank and travel earnings. On Tuesday, I will tune into United Airlines (UAL) earnings. UAL has significant exposure to international travel compared to domestic counterparts. There is a thesis Chinese travelers anxious to stretch their legs after years of draconian COVID policy will boost travel and discretionary earnings for 3-6 months. UAL will have the inside scoop. 

Broadly speaking, I think we are in the early innings of a more enduring shift in investor focus. In 2022, the macro – Fed, inflation, economic growth – triumphed all. Consequently, no matter how good the micro – company-specific earnings – bearishness tended to win out. However, the current level of relative macro-certainty leads me to believe the market will do a better job differentiating winners and losers at the micro-level (single stock level). This shift will only sustain itself if the Fed decides to pause at one of the next two meetings. In other words, as long as we know what sport we’re playing (the macro), we can focus on drafting the best players (the micro). 

As a result, expectations are higher this earnings season than the last. In addition to the point made above, sentiment is better, and prices are higher. It is no secret the Fed is slowing the economy. By now, investors expect management to have planned for it. Earnings will expose the companies that have not prepared and reward those that have. Placing the blame on a “slowing” or “poor” macro will likely be met by deaf ears and rush of selling. To carry-on the analogy, earnings season is the stock scouting combine, and you are the GM.  

Congress Is On The Clock

Aside, the U.S. Government is officially on the debt ceiling clock. Congress has until Thursday to find a resolution to fund themselves. It is the reason defense names in the ITA were bleeding red last week despite the rally. The selling could spill over into the broader market as we approach that deadline without a path to resolution. If this downside continues, it could provide a nice entry point to build defense sector positions. In my opinion, there is still no rush to put money to work here. The damage will continue as long as the debt ceiling is in question. While these stocks will likely rally ahead of a signed and delivered resolution, I’d rather miss the first 5% up than catch an unknown amount down.