US economics, inflation, and the Fed

In their latest report, Value Line emphasizes that inflation remains sticky. This was evident in the latest round of price data that showed notable increases at both the producer (wholesale) and consumer levels. On a 12-month basis, the Producer and Consumer Price Indexes increased 3.5% and 3.0%, respectively, in January. The core readings, which exclude the more volatile food and energy components, also were stronger than expected and ran well above the Federal Reserve’s target rate of 2.0%.

Then there is the debate of whether potential tariffs from the Trump Administration will put further upward pressure on prices. President Trump announced a series of reciprocal tariffs against several international trading partners that are set to take place on April 1st. This followed the announcement of tariffs on goods from China, Canada, and Mexico on February 1st, though the tariffs on our North American neighbors were delayed a month while those nations try to negotiate new trade and immigration deals.

These fiscal policies have to be a concern for the Fed, as it attempts to rein in inflation. Given this backdrop, the central bank is now unlikely to cut interest rates again before the second half of this year, if at all. There are concerns that the reacceleration in the price for goods and services is starting to take a toll on the consumer. The Conference Board’s Consumer Confidence Index declined by 5.4 points, to 104.1, in January. That report also showed consumers were less optimistic about future business conditions and, to a lesser extent, income. Likewise, the University of Michigan’s February Consumer Sentiment Index fell to its lowest level in seven months. On point, U.S. retail sales fell 0.9% in January, a stark reversal from the 0.7% gain registered in December. If consumer spending were to weaken, it could undermine the rate of gross domestic product (GDP) expansion according to Value Line.

Global economy

Looking through the turn-of-year volatility, incoming data remain aligned with JP Morgan’s high-for-long rate narrative in which global growth remains resilient, inflation stays sticky, and central bank easing continues to be limited. Upward pressure on interest rates should also extend out the curve as political forces are expected to tilt fiscal stances away from planned tightening, leaving deficits elevated and pushing the overall global fiscal impulse toward neutral. The recent pressure for increased defense spending in Europe is the latest element of this story.

In normal times, these developments would bolster market’s confidence about the path ahead. However, these are not normal times as the market recognizes heightened risk associated with a Trump administration making substantial changes across multiple policy fronts. The balance of action on trade, immigration, regulatory, and fiscal policy is likely to raise 2025 inflation. But the net impulse on US and global growth is less clear and incorporates the risk of disruptive actions that magnify downside risks to global growth. JP Morgan’s baseline incorporates a commitment by the administration to support US business sector performance that tempers the risks of disruptive policies. Through a flurry of incoming policy announcements, it is hard to discern a strategy amid a range of competing interests and demands. While the bank’s baseline view is unchanged, a lack of coherent signals and aggressive rhetoric fan the downside tail risk concern of more disruptive policy decisions.

The signal from activity releases is that growth appears to be moderating to a still solid pace. The global consumer and Asia tech producers look to be giving back some of their robust 4Q24 gains, and survey data point to a cooling in developed markets service sector activity. Some downshifts are the usual variation in expansion supported by healthy private sector balance sheets, balanced income gains, and favorable financial conditions. More broadly, recent better news from last year’s weak links — global manufacturing, Germany, and China — have lowered these downside growth risks according to JP Morgan.

Stock market

Meanwhile, fourth-quarter earnings season has surpassed expectations. With more than 75% of the S&P 500 companies having reported results as of press time, profit growth has averaged around 17%. If this holds firm, it will mark the strongest year-over-year earnings growth since the fourth quarter of 2021 according to Value Line. While more and more companies report better results, the mega cap horsemen, which carried the market in recent years, show first signs of fatigue. In their recent paper, Empirical Research Partners highlight that, while still producing record cash flows, big tech spends a lot on AI infrastructure, and these huge capital spendings start eating into incremental cash flows and profitability. So, it pays to be more and more selective going forward, as large cap indexes could be suppressed by mega caps, should the latter slow down under the burden of high capex.

Recently at Signet we rebalanced our actively managed portfolios. We always begin with the economic sector’s outlook (see our sector forecast below). We maintain our barbell approach combining promising cyclical and defensive stocks and over-emphasizing more profitable companies. It makes sense to keep exposure to Large Growers of a GARP (growth at reasonable price) nature (Technology, Communications, some Discretionary), which is the cohort of Large Growers outperforming their expensive peers. Their outperformance is justified by record profits and early adaptation of AI. Moreover, we like cyclicals at an attractive valuation level, and we find it appropriate to maintain a healthy exposure to Financials, Industrials and Technology. We have become more attracted to Real Estate as interest rates have stabilized and the housing shortages are substantial. We have warmed up to some Utilities since they will become beneficiaries from increased electricity consumption by data centers on the wave of cloud computing and AI. We maintain adequate exposure to healthcare — the sector proved to be a great hedge in times of higher volatility. So, in a nutshell, as the market turns from an indiscriminative macro driven state to paying attention to individual company fundamentals (especially profitability and growth prospects), it pays to be more selective in each economic sector.

Judging by the Macro Score composition (see below), we should emphasize Growth but still have adequate exposure to Profitability. Value and Yield still play a key role going forward, keeping in mind a reduced probability of a recession this year. Safety is on the backburner for now.

The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results. The information sources used in this letter are: WSJ.com, Jeremy Siegel, Ph.D. (Jeremysiegel.com), Goldman Sachs, J.P. Morgan, Empirical Research Partners, Value Line, BlackRock, Ned Davis Research, First Trust, Citi research, HSBC, and Nuveen.

IMPORTANT DISCLOSURE

Past performance may not be indicative of future results.

Different types of investments and investment strategies involve varying degrees of risk, and there can be no assurance that their future performance will be profitable, equal to any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.

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