Data over the past week confirmed many of the themes we’ve been discussing in 2021: First, manufacturing is leading the post-pandemic economic recovery, which is broadening to other areas. Second, U.S. consumers are spending more as the economy reopens and the government sends out stimulus checks. Third, signs of inflation are emerging as the economy recovers. And the Federal Reserve appears intent to tolerate higher inflation as it continues supporting the labor market, where the rebound has lagged.

The culmination of these themes is a reminder that economic signals are largely positive and will likely continue to be aided by fiscal and monetary policies. At the same time, future inflation is becoming a more credible risk, which can weigh on growth-oriented stocks that have led returns for the past couple of years. We believe that investors can adapt to the changing landscape and hedge the potential risk of rising prices through asset classes such as value stocks, inflation-protected bonds, and commodities while still participating in an expected cyclical uptick in growth.

WALL STREET WRAP

Retail Sales Rebound Sharply: On Wednesday, the Census Bureau posted January advance retail sales figures that blew the doors off. Following three months of negative results, U.S. consumers increased spending by a seasonally adjusted 5.3 percent from December. When you exclude autos, building materials, food services and gasoline, growth was 6 percent.

One month does not make a trend, especially since seasonal spending habits have been more volatile during the pandemic. Even so, this was the fourth highest monthly retail sales growth figure on record. Many shoppers returned to stores after receiving $600 stimulus checks at the beginning of the year, and there are active discussions on Capitol Hill that could send another $1,400 direct payment to qualified individuals this spring.

Production/Utilization Show Steady Growth: The Federal Reserve reported on Wednesday that U.S. industrial production grew 0.9 percent in January, led by manufacturing activity. The data was reported along with capacity utilization, which increased sequentially to 75.6 percent.

Utilization has a close relationship with inflation, so it’s worth keeping an eye on this figure. To put things in perspective, this reading was closer to 80 back in 2018, which is the last time the Fed raised interest rates.

Regional Manufacturing Robust: Both the Empire State (New York) and Philadelphia Fed manufacturing indices surpassed expectations last week. Employment and prices increased in both regions, which tend to be a precursor for the key Institute for Supply Management (ISM) report in a couple of weeks.

U.S. PMI Data Strong, Eurozone Mixed: On Friday, IHS Markit posted the February purchasing managers’ index (PMI) reports for both the U.S. and Eurozone. At home, the manufacturing reading ticked lower from last month but still was solid at 58.5. The Eurozone manufacturing data improved nearly three points, to 57.7. The main driver here was Germany, Europe’s largest economy, which delivered a February reading of 60.6.

The difference between the two regions was decidedly more pronounced on the services side, where the U.S. is running at 58.9 and the Eurozone at just 44.7. Europe has experienced tight COVID-19 restrictions during the winter months, and we expect that figure to rebound (above 50 signifies expansion) as businesses reopen.

Housing Data Mixed But Point to Future Growth: A report of January existing home sales from the National Association of Realtors and a survey from the National Association of Home Builders (NAHB) painted a positive outlook for the housing sector last week. This industry has remained resilient throughout the pandemic, although some metropolitan areas have seen people moving out toward suburban neighborhoods.

January data from the Census Bureau last week offered a more mixed outlook for housing. New home starts fell 6 percent from the previous month, while building permits grew more than 10 percent. The latter is a read on future activity, as many of those permits will likely convert to housing starts down the road.

Producer Prices Leap Higher: While there was a broad range of positive economic data reported last week, it’s important to note some inflation measures continue to rise. The January producer price index (PPI) reported by the Bureau of Labor Statistics (BLS) on Wednesday showed 1.3 percent month-over-month growth. That marked the largest increase since 2009, when the BLS adopted its current measure.

It’s likely that businesses will pass along rising input costs to consumers in the future, but it remains a matter of when. In the meantime, it’s important to note that Jerome Powell and the Federal Reserve have noted a willingness to tolerate inflation in the near term in order support to support a full recovery of the U.S. labor market.

THE WEEK AHEAD

LEI Kicks Off Week: The Conference Board will announce its January reading of the Leading Economic Index (LEI) on Monday. This report has 10 broad components that encompass many of the key themes we’re focusing on.

Will Consumer Confidence Reflect Pent-up Demand? The Conference Board will also post its February consumer confidence reading on Tuesday. U.S. consumers have added nearly $1.2 trillion in aggregate savings during the pandemic and could be looking to spend some of it later this year as business and travel restrictions continue to be relaxed.

PCE Offers Next Read on Prices: The Bureau of Economic Analysis will announce the personal consumption expenditures (PCE) index on Friday, which is the Fed’s key indicator to see whether inflation is rising at the consumer level.

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