Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
A stronger than expected reading from the Federal Reserve’s preferred inflation measure, along with improvements in some economic measures, sent investors heading for the exits last week on fears that the U.S. central bank would continue to raise rates for longer and would eventually push the economy into recession. Last week’s Personal Consumption Expenditure (PCE) index showed that headline inflation rose 0.6 percent in January from the prior month and is up 5.4 percent on a year-over-year basis compared to a year-over-year rise of 5.3 in December. Core inflation, which excludes the volatile food and energy categories, also rose 0.6 percent from the previous month and is now up 4.7 percent from January 2022. The same report shows personal spending jumped 1.8 percent in January, up from a 0.1 percent drop in December.
It is too early to conclude whether last week’s PCE report represents a new trend or is simply statistical noise influenced by seasonal adjustments. Indeed, this isn’t the first time a downward trend in PCE readings has been disrupted by an unexpected uptick. In June 2022, headline PCE jumped 1 percent month over month after rising just 0.8 percent total during the preceding two months. Likewise, June’s year-over-year readings jumped to 7.0 percent, up from May’s level of 6.3 percent. June’s month-over-month core reading nearly doubled to 0.63 percent from the prior month’s increase of just 0.38 percent. We highlight the June reading to underscore our long-held view that the retreat from higher prices will experience occasional bumps along the way. As such, we believe investors should focus on the overall trend of the data. And on that score, we remain encouraged that inflation is receding. Consider that as recently as September 2022, headline inflation was at 6.3 percent year over year, while core PCE was running at 5.2 percent.
Unfortunately, while the trend has been promising, it may not matter as it pertains to interest rates. For months, Fed Chair Powell has highlighted the strong employment picture as a source of concern based on the view that until there is slack in the labor market, employers may be forced to raise wages to attract workers. Those higher wages could then be used by consumers to continue to spend despite higher prices, resulting in an upward inflation spiral — as was the case in the late 1970s through the early 1980s. Details of the latest PCE report showed that wages grew by 0.9 percent in January, slightly below consensus estimates of 1 percent, but spending came in at a much stronger than expected pace of 1.8 percent. Those readings, in our view, are likely to prompt the Fed to continue to raise rates for at least the next few months.
Wall Street Wrap
While much of the focus last week was on inflation and spending, other reports continue to paint a picture of the uneven ebb and flow the economy is experiencing. The sometimes conflicting data has led some investors and financial pundits to bounce between viewing the economy as too hot or headed for recession, often in the same week. When taking a broader view, we see an economy that continues to soften despite a still strong services sector offsetting some of the weakness in manufacturing and the housing market.
Overall, we continue to believe the Fed’s actions will result in a mild and uneven recession.
A rare uptick in growth: The Chicago Federal Reserve’s National Activity report — a measure of 85 monthly economic indicators to measure U.S. economic activity — showed mild expansion with a reading of .23 for January. Readings above zero indicate above trend growth, while readings below zero are interpreted as a sign of contraction. It’s important to note that in November, the measure came in at -.56 and was followed by a December reading of -.46, indicating an economy heading toward recession. Despite the uptick this month, the longer-term trend (with a three-month average reading of -0.26) suggests economic weakness. Prior to the January measure, the last time the index was in positive territory was in September 2022, when it eked out a reading of .04. Given the picture painted by the longer-term trend, we view the latest data point as a sign of the lumpiness that can occur when measuring the economy in real time and one that underscores the importance of monitoring trends.
Preliminary readings from the S&P Global Composite Purchasing Managers Index also showed some stabilization for the economy with the Composite output Index reading of 50.2, up from January’s reading of 46.8. However, the latest numbers show that despite an uptick in activity, manufacturing logged the fourth consecutive month in recession territory, with a reading of 47.8, up from January’s 46.9 (readings below 50 indicate contraction). Meanwhile, production fell for a fourth straight month, and new orders declined sharply.
The services side of the economy perked up, with a reading of 50.5 — indicating modest expansion. This marks the first expansionary reading since June 2022. The rate of cost increases remained elevated but grew at the second weakest pace since October 2020.
Housing market remains cool: The National Association of Realtors reported that existing home sales in the U.S. dropped 0.7 percent in January to a seasonally adjusted annual rate of 4.0 million units. The latest drop marked the 12th straight month of falling sales — the longest streak of declines since 1999. The decline in the annualized rate of sales represents a 36.9 percent drop from the pace recorded in January 2022. The inventory of unsold homes grew to 960,000 as of the end of January, up 2.1 percent from December and 15.3 percent from year-ago levels.
The week ahead
Tuesday: The S&P CoreLogic Case-Shiller index of property values will be out before the opening bell. The report is expected to show a sixth straight month of easing prices, with the year-over-year price changes expected to come in at 4.7 percent, well off the blistering pace of 21.2 percent set in April 2022. These slowing housing numbers should begin to impact the lagging shelter component of the Consumer Price Index in the coming months and result in further declines in inflation readings.
The Conference Board’s Consumer Confidence report will come out in the morning. While gas prices have eased in recent months, we expect inflation concerns will continue to act as a drag on confidence. We will be on the lookout for any changes in trends as well as the labor market differential, which is based on the difference between the number of respondents who believe jobs are easy to find compared to those who report challenges finding work. The measure has weakened by 10.2 percentage points since March, a level that in the past has pointed to a softening labor market.
Wednesday: The health of the manufacturing sector will be in the spotlight as the Institute of Supply Management (ISM) releases its latest Purchasing Managers Manufacturing Index for February. The last three readings of this report have shown the manufacturing sector in contraction, with demand subsiding and supply levels returning to normal. Recent readings of this report have shown demand for manufactured goods contracting, while inventories have risen. The ISM services report will come out on Friday, and we will be watching the two for updates on the strength of the overall economy.
Thursday: Initial and continuing jobless claims will be announced before the market opens. Initial filings fell modestly last week, and we will be watching for any signs of loosening of the employment picture.
NM in the Media
See our experts' insight in recent media appearances.
Brent Schutte, Chief Investment Officer, discusses his market outlook for 2024. Listen
Brent Schutte, Chief Investment Officer, discusses why small cap stocks look attractive despite the threat of a recession. Watch
Brent Schutte, Chief Investment Officer, discusses his outlook for inflation, wages and the likelihood of a recession. Watch
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As the chief investment officer at Northwestern Mutual Wealth Management Company, I guide the investment philosophy for individual retail investors. In my more than 25 years of investment experience, I have navigated investors through booms and busts, from the tech bubble of the late 1990s to the financial crisis of 2008-2009. An innate sense of investigative curiosity coupled with a healthy dose of natural skepticism help guide my ability to maintain a steady hand in the short term while also preserving a focus on long-term investment plans and financial goals.
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