The Word from Main Street

Market Update for the Week of February 19th, 2024

Higher-than-expected CPI data drives market selloff, especially for small caps. The recent CPI report drove a selloff in the markets. The Nasdaq-100® ETF (chart below, blue line) and Nasdaq Mid-Caps ETF (orange line) both fell nearly 2%, and the Nasdaq Small-Caps ETF dropped 5.5% (green line). The disappointing CPI report also pushed up rates, with 10-year Treasury yields rising 15bps (0.15%) to 4.3%, as markets pushed back expectations for the first Fed rate cut to June from May. 

This helps explain the bigger selloff in small caps since they typically have more floating rate debt, making them more rate sensitive. 

Source: Nasdaq Dorsey Wright

Core services and housing kept inflation higher. Why were markets so disappointed by this CPI report? Simply put, headline and core inflation didn’t fall as much as expected. Headline CPI inflation slowed to 3.1% YoY (chart below, orange line), but markets expected 2.9%. And core (which excludes food and energy) was unchanged at 3.9% YoY (chart below, orange line) against expectations it would fall to 3.7%. The higher-than-expected result was mostly due to two categories: housing (purple area), which is still up 6% YoY, and core services ex housing (blue area), which is back above 4% YoY. (The report wasn’t all bad news, though. Core goods (red bars) and Energy (black bars) remain a drag on inflation.)

Source: Nasdaq Dorsey Wright

Leading indicators suggest core services and housing inflation should keep slowing. So should we expect housing and core services to hold up inflation now? Fortunately, their leading indicators suggest this report might be a one-off, and we believe they should keep slowing from here…

1 - The 2.5-year low in Zillow’s new rent inflation points to slower housing inflation. Zillow’s new rent inflation remains in the downturn that began in early 2022, having plateaued at a 2.5-year low for the last six months (chart below, blue line). So, although housing inflation didn’t fall as much as expected this month (purple line), the lower new rents inflation will weigh on overall housing as they filter into the CPI sample.

Source: Nasdaq Dorsey Wright

2 -The 3-year low in the quits rate indicates wage-driven core services inflation will slow further. Core services ex housing is mostly wage driven, so we look to the labor market. The quits rate acts as a leading indicator of wage growth because if fewer people are quitting, that means the labor market is loosening, which takes pressure off wage growth (chart below, blue line). With the quits rate down to a three-year low (pink line), we believe we should see wage growth and, in turn, core services ex housing inflation, slowing in the coming months. 

Source: Nasdaq Dorsey Wright

Leading indicators of inflation suggest markets may have overreacted to January CPI. With the leading indicators for the key drivers of inflation pointing to further slowing still to come, it looks like markets may have overreacted to the recent inflation data.

The current reading for the Nasdaq Dorsey Wright PR4050 Cash Trigger is: Money Market = 9.86% & U.S. Equity Core = 98.59%. For the PR4050 indicator to trigger and alert us when we should consider moving to cash, Money Market must be 50% or above and U.S. Equity Core must be 40% or below.

Source: Nasdaq Dorsey Wright

Below is the most recent D.A.L.I. (Dynamic Asset Level Investing) Indicator showing Domestic Equities in the top spot with a nice spread between all other asset classes.

Source: Nasdaq Dorsey Wright

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Nasdaq Dorsey Wright’s “DALI" employs relative strength-based analysis to rank macro asset classes based on developing leadership trends within the global capital markets. The objective guidance within DALI provides the tools necessary to properly allocate portfolios across all major asset classes in an effort to emphasize strength wherever it exists. Domestic Equities, International Equities, Commodities, Currencies, Fixed Income and Cash are evaluated daily to identify dynamic developments across investment genres, as well as within them. This tool provides the tactical precision that allows investors to adapt as the market leadership changes.