Week in Review: November 17, 2023

Inflation is inching in the right direction

 

Market summary

U.S. equities rallied this week as the S&P 500 and Nasdaq both ended the week with a third straight week of gains, while the small-cap Russell 2000 posted its second-best weekly performance of the year. All sectors were higher for the week, though outperformers leaned toward cyclical sectors. Treasuries rallied across the curve, with the 2-year yield falling to 4.8% at one point, the lowest since early September, while the 10-year ended the week around 4.45%. 

This week

Retail sales weren’t quite as weak as most expected in October, but the data showed a fairly broad-based slowdown in spending (see Figure 1). The Consumer Price Index (CPI) was unchanged month over month (MoM) and rose by a softer 3.2% year over year (YoY) at the headline level in October, following a 3.7% YoY rise in September (see Figure 2). We expect that inflation will further slow throughout the year but will take time to reach the Federal Reserve’s 2% goal and remain volatile, as energy and housing prices remain elevated in the near term. October’s inflation report supports our view that the Fed will keep rates higher for longer to restore price stability. 

Headline CPI was unchanged MoM in October as the rise in core prices offset the decline in gasoline prices. Meanwhile, the decline in the headline YoY CPI in October was driven by a drop in energy prices, as gasoline prices fell by 5% MoM. We expect gasoline prices to remain volatile and elevated in the upcoming months, despite some potential easing in November. Volatile energy prices will keep the headline inflation data elevated over the near term and weigh on the consumer as purchasing power is diminished. Food prices increased by 0.3% MoM in October and are expected to contribute only slightly to inflationary pressures in the upcoming months. 

Core CPI (excluding food and energy) rose by a surprisingly softer 0.2% MoM in October and by 4% YoY, the lowest level since September 2021. Each major component of core inflation reflected signs of easing, reaffirming the Fed that inflation is trending in the right direction. We expect that core inflation will moderate this year as the economy and labor market soften; however, it will take longer to reach the Fed’s goal as services inflations remains sticky. 

Core goods prices declined by 0.1% MoM in October, declining for the fifth straight month. Core goods prices were weighed down by declines in new and used vehicle prices, down by 0.1% and 0.8% MoM. Prices were driven down by easing inventory conditions after a shortage of semiconductors that increased prices over the past few years. The recent United Auto Workers strike could temporarily reduce inventory but only in the short term in our view, with no significant impact. Overall supply chain conditions continued to ease and will likely add to deflationary goods pressures in the near term. We expect the price of goods to continue to moderate throughout 2023 as consumer demand further weakens due to high interest rates and tight monetary policy. 

Core services inflation remains the stickier side of the inflation equation, which the Fed is laser focused on slowing. The softer surprise was driven by a moderate 0.3% MoM in the shelter component, which remains the main driver of core services inflation and accounts for one-third of the overall CPI. This was driven down by a slower 0.4% MoM rise in owners’ equivalent rent  and a 0.5% rise in rents. Shelter prices need to decline for headline inflation to materially weaken. Although changes in housing prices have a lagged effect on the housing component of the CPI, and we expect rental prices to soften later this year and into next year. 

The Fed has been laser focused on its new preferred measure of inflation, core services inflation (excluding housing), which continues to trend downward on an annualized basis. Core services inflation (excluding housing) rose by only 0.2% MoM in October, the smallest increase since July. However, we expect that the Fed will focus on the longer-term downtrend in the annualized number, and that will give it comfort that inflation is moving in the right direction. Core services inflation (excluding housing prices) is largely driven by the domestic economy, particularly the labor market and nominal wage growth, which we expect to moderate throughout the year. Overall, October’s core service inflation (excluding housing) shows promise that inflation is moving in the right direction and will give the Fed another data point that inflation is slowing. 

As of this writing, Congress passed a continuing resolution that will keep the federal government funded through the holidays. Earlier this week, Congress approved a clean continuing resolution that will extend funding at its current level for 4 of the 12 appropriations bills through January 19 and through February 2 for the remaining 8.

Going forward

The fundamental floor for risk assets including equities has risen in recent weeks as data continues to suggest that downside prospects for economic growth aren’t as severe. We expect pockets of volatility to persist as policymakers and investors alike are increasingly data dependent. Fixed income markets will need to adjust for the reality of “higher-for-longer” rates. We’ve become more neutral in our top-line positioning but maintain a defensive growth tilt underneath. We’d advocate using periods of market weakness as opportunities to upgrade portfolios. 

Within equities, we continue to favor U.S. large-cap exposure, since China’s evolving COVID policies continue to weigh on manufacturing and international trade activity. We’ve recently become more constructive on Japanese equities, relative to Europe, as the mix of policy and growth appears more favorable. In the United States, large-cap equities provide an attractive blend of quality, yield and growth at a reasonable value, albeit at higher valuations. We advocate for more “equal weight” as opposed to “cap-weighted” exposure and believe that a “catch-up, melt-up” phase could lead underperforming segments to enjoy gains moving forward. Within fixed income, we favor duration at close to, or slightly above, neutral. We remain defensive in our credit positioning and higher in credit quality. Even as the economic backdrop appears more benign, we remain on guard for the potential that credit spreads will leak wider.

Happy Thanksgiving!
Next week there won’t be a Week in Review due to the holiday. 

 

THE WEEK AHEAD

• Existing home sales are expected to soften at 674K and will be released on Tuesday. 
• October’s durable orders (preliminary reading) are expected to contract by 3.5% MoM and will be released on Wednesday. 
• November’s Michigan Sentiment Index is expected to slightly increase to 60.7 and will be released on Wednesday. 
   

Figure 1: Retail sales by category: October 2023 

 

Sources: Bloomberg, J.P. Morgan Private Wealth Advisors, as of November 16, 2023.

Figure 2: U.S. CPI breakdown

 

Sources: Bloomberg, J.P. Morgan Private Wealth Advisors, as of November 16, 2023.

 

 

Market Returns (USD) as of 11/16/2023

Market Levels

Sources: Morningstar, FactSet

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