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‘Higher for Longer’ after May Core PCE
May’s print for Core PCE came in 4.6% YoY – still well above the Fed’s objective of 2.0%. However, mainstream were quick to label the report as ‘lackluster’. Why? Here’s the thing – Core PCE has hardly changed the past few months. It dipped in May to 4.62%, from April (4.68%), but was above March (4.61%), and was exactly where it had been in December (4.62%). Put another way – we have made no ground since December – and yet it was now somehow ‘lackluster’. But it gets better: core services inflation (without energy services) rose by 5.4% in May YoY. It was fractionally lower than April (5.5%) – but equal to what we see in both March and December (5.4%). Similar to Core PCE – it too is stuck in a tight range for 5 consecutive months. What does all this mean? Simple: rates will be higher for longer and markets don’t get it.
Stocks Are Not Cheap
The S&P 500 has had a fantastic first 6 months of the year – up almost 15%. That’s a welcomed relief from the miserable 2022. But are stocks now too expensive? What’s the premium investors are being asked to pay? There are a couple of ways we can assess this. For example, we can compare the earnings yield against the risk free rate of return (currently around 5.5% and going up). And whilst it’s always good to maintain some (long) exposure to the market – we need think carefully about how much (and where)
Why Is it Different This Time?
Whenever history looks like repeating – it’s worth asking what’s different this time? I say that because the past is never a guarantee of what’s ahead. Put another way, if you are making decisions on that basis, you might be suffering from “confirmation bias”. And that can be a blind spot. My (possible) blind spot is I think a recession is more than likely within the next 12 months. As such, I am only willing to put about 65% of my portfolio in risk assets. If I felt a recession was not likely – I would meaningfully increase my exposure. My bias is to lean into historical data (and leading indicators) which have reliably predicted recessions in the past. That feels logical. But I could be wrong.
S&P 500 Meets Resistance
There’s a few good reasons to be bullish: (i) Q1 earnings were better than feared; (ii) Bank deposits have stabilized; (iii) Inflation is slowly (but surely) working its way down; (iv) The Fed is closer to its terminal rate; and (v) We’re yet to see any major deterioration in credit. All of those are positives for risk assets. However, stocks have run a long way fast and are due to take a pause. I think that’s what we will see…