If today’s stock market had a theme song, it would be “Fly Me to the Moon.” It was written in 1954 by Bart Howard and recorded by lots of top singers. Frank Sinatra and the Count Basie Orchestra recorded a version of the song arranged by Quincy Jones in 1964. “Fly me to the moon / Let me play among the stars”: Those lyrics could as easily be about an investor frolicking in today’s stock market as a fellow smitten by love. Investors love the stock market these days! It has aroused their animal spirits. They are sending it to the moon, and going right along with it. What’s not to love about the S&P 500, which is up 3.1% so far this year? It is up 41.6% since the Xmas Eve bottom on 12/24/18, 55.6% since Trump was elected president, and 392.2% since the start of the current bull market (Fig.
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What’s not to love about the S&P 500, which is up 3.1% so far this year? It is up 41.6% since the Xmas Eve bottom on 12/24/18, 55.6% since Trump was elected president, and 392.2% since the start of the current bull market (Fig. 1, Fig. 2, and Fig. 3). The S&P 400 and S&P 600 are up 417.9% and 471.7% since the start of the bull market.
I reckon that the most recent meltup started last year on 10/2 (Fig. 4). That coincided with widespread expectations that the Fed would lower the federal funds rate for the third time in 2019 to a range of 1.50%-1.75% at the 10/29-30 meeting of the Federal Open Market Committee (FOMC), which is exactly what happened. Immediately after that meeting, Fed Chair Jerome Powell really aroused investors’ love for stocks when he said during his post-meeting press conference, “So I think we would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”
Those words were music to investors’ ears. Inflation has remained persistently below 2.0% since that became the Fed’s official target for the personal consumption expenditures deflator (PCED) measure of inflation during January 2012 (Fig. 5). Apparently, Powell’s soothing words convinced many investors that the federal funds rate could remain unchanged through the end of the current decade, or at least until the next inflation number confirmed that the Fed could remain “patient,” to use Powell’s lingo.
In his press conference, Powell said, “We entered the year  expecting some further rate increases, we went to ‘patient,’ now we’ve done three rate cuts. It’s a very substantial shift, and the effects of it will be felt over time. So we feel like those shifts are appropriate to support exactly the outcomes you’re talking about, which are a continuing strong labor market, continued strong job creation.”
So the Fed is back to patient with the federal funds rate range at 1.50%-1.75%, down from 2.25%-2.50% at the start of 2019. What Powell didn’t say was that his renewed patience after the Fed lowered the federal funds rate three times has been wildly bullish for stocks, as evidenced by the meltup since Powell said what he said last October.
That’s only fitting. Recall that it was only a year before, on 10/3/18, that Powell triggered a meltdown in the stock market by saying, “Interest rates are still accommodative, but we’re gradually moving to a place where they’ll be neutral.” He added: “We may go past neutral. But we’re a long way from neutral at this point, probably.” The S&P 500 crashed nearly 20% as a result.
The refrain in the love song “Grease,” from the musical of the same name, is “Grease is the word.” For the stock market, “inflation” is the word. As long as it remains persistently below 2.0%, the Fed will remain on hold. So we need to watch the inflation indicators very closely and give them more weight in our thinking about the outlook for stocks. Low inflation should continue to grease the bull market. Now let’s review a few of the latest key inflation numbers:
(1) CPI. Last year, the core Consumer Price Index (CPI) rose 2.3% y/y through December. That’s above the Fed’s 2% target, but that target is for the PCED rather than for the CPI. In any event, the headline and core CPI inflation rates were up only 0.2% m/m and 0.1% during December. Over the past three months through December, the core CPI was up 2.0% (saar) (Fig. 6).
(2) PCED. The PCED inflation rate is available through November of last year, and its headline and core rates rose 1.5% and 1.6%, respectively. Over the past three months through November, the core rate is up just 1.3% (saar). If you are looking for more inflation, you’ll find it in the services component of the PCED, which was up 2.2% y/y through November (Fig. 7). If you are looking for deflation, you’ll find a bit of it in the goods component of the PCED, which was down 0.3% y/y through November.
By the way, a footnote in the FOMC’s February 2000 Monetary Policy Report to Congress explained why the committee decided to switch to the inflation rate based on the PCED:
“The chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI. The PCE chain-type index is constructed from a formula that reflects the changing composition of spending and thereby avoids some of the upward bias associated with the fixed-weight nature of the CPI. In addition, the weights are based on a more comprehensive measure of expenditures. Finally, historical data used in the PCE price index can be revised to account for newly available information and for improvements in measurement techniques, including those that affect source data from the CPI; the result is a more consistent series over time.”
The CPI continues to have an upward bias, as demonstrated by the ratio of this price index to the PCED (Fig. 8).
(3) PPI. Despite rising tariffs last year, the US import price index excluding petroleum was down 1.5% y/y through December, matching its slowest pace since June 2016 (Fig. 9). That helped to keep a lid on the finished goods Producer Price Index (PPI) excluding food and energy, which rose only 1.5%, the lowest since September 2016.
(4) AHE. Wage inflation, as measured by average hourly earnings (AHE) for production and nonsupervisory workers on a y/y basis, seemed to be making a big comeback last year when it rose to 3.6% during October, the fastest since February 2009 (Fig. 10). But it fell back to 3.0% during December.
I don’t view wage gains as inherently inflationary. On the contrary, I believe that wages tend to rise faster than prices, and don’t exert upward pressure on prices, when productivity growth is improving. That may very well be happening now. Inflation-adjusted AHE growth has been tracking a 1.2% per year trend since December 1994 (Fig. 11). Real AHE rose 1.9% y/y through November.
(5) Fed target. During the aforementioned press conference, Powell was asked by the WSJ’s ace Fed watcher Nick Timiraos how soon the Fed’s review of its inflation-targeting procedure would be announced to the public. Powell answered: “So we’re in the middle—we’re really quite in the middle of it now, and my thinking is still that it will run into the middle of next year. These are—you know, these changes to monetary policy frameworks happen—they don’t happen really quickly, let’s say. Inflation targeting took many years to evolve. I don’t think we’ll take many years here. I think we’ll wrap it up around the middle of next year, would be my guess. I have some confidence in that.” Odds are that not much will change.