The Post-CPI Playbook: 3 Stocks to Buy for Market-Beating Returns
Investors are already probing stocks to buy after April's inflation fell more than projected last week. According to the CPI report, both core and headline inflation figures are trending downward.
Morning Bid: Nvidia nears, UK CPI lunge misses target
A look at the day ahead in U.S. and global markets from Mike Dolan
7 Stocks to Scoop Up as Last Week's CPI Shifts Market Sentiment
The latest CPI report indicated that inflation is once again cooling. CPI only increased by 3.4% year-over-year and was up by 0.3% in April.
Anticipating A Mid-Cycle Slowdown
DNY59 The major market averages achieved new all-time highs last week, with the Dow Jones Industrials (DJI) surpassing 40,000 at the close on Friday. This should come as no surprise to those investors who focused on positive rates of change in the high-frequency economic data over the past two years, led by the rate of inflation. The Consumer Price Index (CPI) peaked in June 2022 at 9.1%, which coincided with the lowest levels in the Russell 2000 (RTY) index during the last bear market. The core CPI peaked at 6.6% in September 2022, which was one month before the bear market low for the S&P 500 (SP500). Ever since, we have seen a gradual and steady decline in the annualized rates for both, as the major market indexes have ground higher with the typical corrections and pullbacks along the way that we should expect. Edward Jones I began discussing my outlook for a soft landing around the same time inflation was peaking in the summer of 2022, whereby the rate of economic growth would slow under tighter financial conditions, bringing the rate of inflation back down to the Fed's 2% target without resulting in a meaningful rise in unemployment or a recession. That is what has largely played out, but the finish line has seemed elusive recently, as some components of the inflation gauges, led by shelter, are taking longer than others to cooperate. Still, the overall disinflationary trend remains intact, which is why interest rates have resumed their downtrend and risk asset prices have recovered. Can it continue? Edward Jones The durability of this expansion has everything to do with the foundation on which it was built, and it is a strong one. The recovery coming out of the last recession was instigated with an unprecedented amount of fiscal stimulus from the bottom up. In other words, we put money directly into the pockets of consumers, with a focus on lower- and middle-income households. They have a far greater propensity to spend than do upper-income households that are more likely to save. As a result, this was a far more robust and speedy recovery than what we saw following the Great Financial Crisis, which was predominantly fueled with monetary stimulus. Ultra-low interest rates don't help consumers at the onset of a recovery who are not qualified to borrow. We also saw the largest wage increases for the same demographic, as the lowest-wage workers realized the highest percentage increase in inflation-adjusted wages over the past four years. EPI The primary fuel for our economic growth is consumer spending, and this combination of fiscal stimulus and real wage growth is what has powered it up to this point. As the rate of consumer spending growth has softened, doubters are focusing on debt levels and the typical deterioration we see in credit at the bottom end as an expansion matures. These don't concern me for now, as the total amount of consumer debt is irrelevant in comparison to the ability to service it. Debt service payments as a percentage of disposable income sit at historically low levels. FRED Our economy is far less interest-rate sensitive than it has been in previous business cycles, which is mostly due to the mortgage refinancing that occurred during the near-zero interest rate period that followed the pandemic. Consumers can take on more debt because of their lower overall cost of total debt outstanding relative to income. This is why I see the soft landing coming into view during the second half of this year, and the stock market is pricing in that development with its year-to-date market gains. This expansion should continue into 2025, during which we experience a mid-cycle slowdown in the economy like what we saw in the mid-1990s. It is an extremely bullish backdrop for risk asset prices. Yet, the stocks that have fueled the S&P 500's 52% gain since the beginning of this bull market in October 2022 are not likely to be the ones that fuel its next leg up. Over the past month, we are finally starting to see small-cap stocks (IWM) rebound to the extent that they are outperforming the S&P 500 (SPY) and Nasdaq 100 (QQQ). There have been brief periods over the past 12 months when this occurred, but then the outperformance for small-cap stocks fizzled. I think this one may have legs, as the consensus grows around the outlook for a soft landing during this mid-cycle slowdown for the U.S. economy. StockCharts
Economic Charts Point To Slower Growth And Lower Inflation
cemagraphics The US economy grew 3.1% last year, trouncing widespread calls for a recession and exceeding my relatively sober expectation for 2% growth. With growth apparently persisting this year, and with popular inflation numbers marginally higher than the Fed's target, both the market and the Fed now question whether and by how much the Fed should cut rates. The prevailing market wisdom holds that the Fed will cut rates once before year-end; they might move sooner, however, if the economy shows clear signs of slowing down and year over year inflation falls below 2%. I continue to argue that the Fed has essentially reached its inflation target. M2 money growth has been flat to negative for two years, and inflation ex-shelter costs (which are artificially inflated due to the BLS's faulty measurement) have declined to the Fed's target. Moreover, today's interest rates are high enough to almost paralyze the housing market, high enough to keep the dollar strong, and that in turn is enough to depress most commodity prices. Fortunately, credit spreads are still quite low, and, when combined with plentiful liquidity, it's not hard to conclude that monetary policy is not tight enough to precipitate a recession. The correct way to view the interplay between growth and inflation is to first understand that high inflation is bad for growth, while low and stable inflation is conducive to growth. Economic growth by itself does not cause inflation - only monetary policy does. As my mentor John Rutledge explains it, inflation is like fog on the highway; it forces everyone to slow down because of a lack of visibility. Inflation creates uncertainty about the future value of the dollar, the level of interest rates, and prices. Reducing inflation thus eliminates uncertainty and promotes investment, which in turn drives growth. In short, the economy grew so much last year because inflation fell. The charts which follow have several messages: 1) interest rates are high enough to cause some serious problems in the housing market, while at the same time boosting the dollar and keeping downward pressure on commodity prices, and 2) some sectors of the economy - manufacturing, international trade, small businesses, commercial real estate, and the service sector in general - are struggling even as the high tech sector continues to boom, and corporate profits are showing healthy growth (which is why the stock market is moving higher). Chart #1 The average rate on mortgages held by the public is 3.9% or so, whereas the current mortgage rate for new 30-yr loans is 7.2%. This creates a powerful incentive to avoid selling one's home because acquiring a new mortgage is extremely expensive. It also depresses the demand for housing because 7.2% mortgage rates make home prices quite unaffordable for the vast majority of people. Housing supply and demand are both very constrained, with the result that the market is not likely in an equilibrium situation. Conditions could change dramatically at any time. Chart #1 also shows that the spread between mortgage rates today and 10-yr Treasuries (the backbone of the mortgage market) is elevated. Why? Because investors are reluctant to buy 30-yr mortgages that could turn into very short-term interest rate loans should Treasury yields decline (because those who borrow at today's high rates would rush to refinance if rates fell). In sum, homeowners don't want to sell, buyers don't want to buy, and lenders (investors) don't want to lend. Again, this is not a healthy market and these conditions cannot persist much longer. Chart #2 As Chart #2 shows, housing hasn't been so unaffordable for many decades. Chart #3 Chart #3 shows that the volume of new mortgage applications is at very low levels, having dropped by roughly 75% since the heydays of 2005-2006. Chart #4 As Chart #4 shows, and as is consistent with the big decline in new mortgage applications, the volume of home sales is very low from an historical perspective. Chart #5 As Chart #5 shows, housing starts are weak because builders are not confident that the outlook for the housing market is healthy. Modest growth in home construction will not be a source of stronger overall growth. What is clear is that the housing market needs a significant decline in interest rates in order to improve. Chart #6 As Chart #6 shows, industrial production in the US has been flat for several years. Meanwhile, industrial production in the Eurozone is suffering from recessionary conditions. The US economy is the global economy's primary engine of growth these days, but it is not very impressive. Chart #7 World trade volume (Chart #7) surged from 2000 through 2019 but has since stagnated. Geopolitical tensions undoubtedly explain most of this, but without an increased pace of trade, the global economy is lacking a key engine of growth. Heaven helps us if war spreads to Europe and throughout the Middle East. Chart #8 As Chart #8 shows, small business optimism is very low. Small businesses are essential to the overall health of the economy, so this is a troublesome sign. Likely culprits: increasing regulatory burdens, high inflation, high tax burdens, green energy subsidies which incentivize unproductive investment, geopolitical tensions, and the political polarization which increasing divides the economy. Chart #9 Chart #9 shows that commodity prices have a strong tendency to move inversely to the strength of the dollar. (The dollar is plotted on an inverse y-axis, so a falling blue line means a stronger dollar.) What stands out here is that commodity prices are unusually strong relative to the dollar. But their ability to rise appears to be constrained given the dollar's ongoing strength. Chart #10 Chart #10 tells us that the dollar's strength owes a lot to the fact that US interest rates are much higher than those in Europe and the rest of the developed world (the blue line represents the spread between 2-yr US and German yields). Stronger US growth and more attractive yields combine to enhance the appeal of the dollar vis a vis other currencies. This is in turn helps depress commodity prices, which also helps to restrain inflation. Chart #11 Chart #11 tells us that the commercial real estate market is facing serious problems. On a value-weighted basis, commercial property prices have fallen 20% from their July '22 high. By the same measure, office property prices (not broken out here) have fallen 34.5% from their all-time high. Chart #12 Chart #13 Chart #12 suggests that business activity in the service sector of the economy (by far the largest sector) has fallen significantly of late. Chart #13 shows that that less than half of service sector businesses plan to increase the number of jobs. By this measure, the service sector could be experiencing recessionary conditions. It also reinforces the message of Chart #8 (small business optimism), and together the two tell a troubling story. Chart #14 Chart #14 shows the year-over-year change in the number of private sector jobs according to the establishment survey. (Private sector jobs are the only ones that really count, in my opinion.) Jobs are growing at a relatively moderate 1.7% annual pace, which is nothing to get excited about. If this were to continue, it would probably be enough to sustain an overall pace of growth for the economy of about 2.5%-3.0% per year - which is at odds with all the charts above that tell of weakness. What stands out here is the rather significant deceleration of jobs growth since the beginning of 2022. This is not a boom, but neither is it a bust. Yet. Chart #15 Chart #16 Chart #15 is an updated version of a chart I have been featuring for months. What it says is that if it weren't for the way the BLS computes housing prices (which is based on the year-over-year change in housing prices 18 months ago), inflation today would be within the Fed's target range today. (The Fed is targeting 2% inflation in the Core Personal Consumption Deflator, which is equivalent to about 2.5% in the CPI because the CPI tends to exceed the deflator by roughly 0.5% per year.) Chart #16 all but proves that the BLS uses ancient housing prices to compute today's rate of shelter inflation. The red line has been falling almost exactly in line with the yoy change in housing prices 18 months ago. If this relationship holds, then the red line will fall from 5.8% today to about 2.5% by October, and this would in turn subtract a significant amount of shelter inflation from the overall CPI. On balance, I see the risks pointing to weaker rather than stronger growth, and lower rather than higher inflation. If the economy weakens, interest rates are quite likely to fall, and that will reduce the threat of further weakness. I think the stock market sees this as well, in the form of what is called a "Fed put," or what is akin to a hedge against recession. Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
3 Small-Cap Stocks on Fire After CPI-Fueled Russell 2000 Rally
At long last, price levels in the United States are settling. The U.S. April CPI report communicated broad-based inflation of 3.4% and core inflation of 3.6%. These figures were lower than March’s numbers of 3.5% and 3.8%, respectively, presenting a base case for a stock market rally. This has led to some very undervalued small-cap stocks. You might be wondering why lower inflation can lead to a market rally. The answer is linked to discount rates. Lower inflation translates into lower discount rates on future corporate earnings, which often results in higher stock valuations. The Russell 2000 has ticked up in the past five trading days, providing testimony to the above. Of course, lower implied discount rates aren’t the only factor influencing stock prices. However, it’s salient enough for me to highlight a few small-cap investment opportunities. Without further ado, here are three small-cap stocks worth considering after last week’s CPI news. Limbach Holdings (LMB) Limbach (NASDAQ:LMB) is an overlooked American construction and renovation company. The firm operates via two segments, namely General Contractor Relationships and Owner-Direct Relationships. Among its key functions are mechanical, plumbing, building controls, and electrical services. Although under the radar, Limbach’s stock has jumped by approximately 1.3x in the past year. Much of its gains derive from robust fundamental performance. However, accretive acquisitions have played a critical part. For example, Limbach recently acquired Industrial Air at its enterprise value of $13.5 million, concurrently phasing in $30 million in revenue potential and cross-sales synergies. The Industrial Air acquisition is merely one example of Limbach’s solid execution in its niche industry. I believe a sustained acquisition strategy accompanied by a recent first-quarter earnings-per-share beat of 30 cents, and a price-to-earnings-growth ratio of 0.22x sets LMB stock up for victory. Aris Water Solutions (ARIS) Water scarcity is a serious societal concern, which naturally gives rise to not-for-profit and for-profit opportunities within the arena. I believe Aris Water Solutions (NYSE:ARIS) will play a critical role in the commercial water recycling industry. It primarily operates as a recycling business in the oil and gas industry. Its presence in the Permian Basin has delivered robust preliminary results, leading the company to sustainable net profitability within ten years after its inception. Aris Water Solutions achieved $16.8 million in net income during its first quarter, translating into a net profit margin of approximately 16.25%. Moreover, the company possesses a three-year compound annual growth rate of 33.13%, showing that its top and bottom lines have additional growth potential. In essence, the data suggests there is untapped shareholder value in play. There is no doubt that Aris Water Solution has yet to reach a consolidation phase. Nevertheless, the firm has a hot concept. Moreover, it has illustrated robust financial results and has $324 million in available liquidity to expand on its key verticals. I’m bullish here, folks! Immersion Corporation (IMMR) Fortune Business Insights forecasts that the haptic technology market will grow at an annualized rate of 13.6% until 2030. Although some market researchers might forecast different growth rates, most think the industry is set up for exponential growth. As such, I looked for best-in-class market participants, leading me to Immersion Corporation (NASDAQ:IMMR). Founded in the early 1990s, Immersion Corporation is a haptic technology market participant emphasizing the development and licensing of touch feedback technology. Its five-year compound annual growth rate of 18.16% speaks volumes, especially considering its well-placed price-to-earnings ratio of 6.8x. Additionally, to my knowledge, Immersion Corporation is debt-free, allowing its shareholders full access to its residual book value. Furthermore, Immersion Corporation recently strolled past its fourth-quarter earnings estimates, delivering a revenue beat of $2.16 million and an earnings-per-share beat of 36 cents. This conveys the firm’s resilient short-term results, which could coalesce with Immersion Corporation’s sumptuous trend growth to deliver its shareholders perpetual returns. IMMR stock trades above its 10-, 50-, 100-, and 200-day moving averages, suggesting a trendline has shaped. I think it is time to ride the wave! Do yourself a favor and grab these small-cap stocks. On the date of publication, Steve Booyens did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
