Inflation is back in the news: The latest reading of the consumer price index (CPI) came in at 3.5 percent. Does this mean all is lost in the Fed’s fight and it is time to sell everything? No, of course not.
The worry on Wall Street is that higher inflation means that interest rates will go higher, which will drive stock prices down. We have made two statements in our Research and Commentary over the past year that still hold true: The first is that it should surprise no one that the last 1 percent of inflation will be the most stubborn. This rise from 3.2 percent to 3.5 percent does not mean that the battle is lost and the Fed must keep rates higher. Nothing in nature goes in a straight line, and inflation will always vary from month to month.
The other observation we have noted is that interest rates, and oil prices for that matter, are simply trading in a range. We were near the lows of that range when I wrote that, and sure enough, we are now heading to the top of the range. Interest rates on the 10-year Treasury are trading around 4 percent. They have gone as low as 3.8 percent and as high as 5 percent, and now are near 4.5 percent; this is closer to the top of the range, and they will likely head back down closer to 4 percent once more. Could they break out of the range and keep rising? Anything is possible, but it is not likely. As of now, nothing has really changed. We remain in a range.
The same is true for oil. I said that oil was in a range between $70 and $90. When I noted that, oil was going down and was near $71. It is now going up and near $85. It is still in the range. Nothing has really changed.
Stocks have sold off on this data and of course the pundits are predicting doom as per usual. The truth is that the market has come a long way over the last six months, and it would not be surprising at all to see a step backwards before going forward once more. This is how the market works. It does not go in a straight line; the trends, however, remain strongly upward.
Can that continue if the Fed does not cut rates? Of course it can. The truth is that the economic data shows we do not need a rate cut. The economy continues to be resilient. The Atlanta Fed’s GDPNow reading shows the economy growing at 2.4 percent as of April 10. This means that corporations as a whole should be growing earnings, and it is earnings that drive stock prices, not interest rates.
I have said it many times, but when it comes to the real economy, the power of the Fed seems to be greatly exaggerated. This won’t stop Wall Street traders from fixating on Fed policy, as it certainly has an impact on markets in the short term. Longer term investors, however, can rest assured that it is the real-world results from the companies themselves that drive long-term stock prices.
We may get a correction if the Fed decides not to lower rates in June, but corrections are normal. Nothing goes in a straight line – not inflation, not oil prices, not interest rates, and certainly not stock prices. We are still on course.
Warm regards,
Chuck Osborne, CFA
Managing Director
