Investor Worries Have Shifted from Inflation to Growth
For the better part of two years, it seemed like every economic and market-based conversation revolved around inflation. Would inflation continue to trend lower? Would the Federal Reserve need to keep raising interest rates to fight rising prices? When would inflation finally reach a level that allows the Fed to pause rate hikes or even begin easing?
It was inflation, inflation, inflation … Fed, Fed, Fed.
But there’s an interesting element to this story and period that I don’t think is widely appreciated. While many investors and the financial media remained fixated on inflation as an outsized economic risk, the stock market digested the impact relatively quickly and then moved on. It’s a reminder that too much focus on the news cycle can work against investors. The stock market prices in the future, not the present or the past.
In the chart below, I show the consumer price index measure of inflation (blue line, left axis) and the S&P 500 (red line, right axis). As readers can see, inflation was still over 7% year-over-year when the bull market kicked into gear. While 2023 was all about recession odds, rising interest rates, and sticky inflation, stocks were already pricing in a peak in the interest rate cycle and forward-looking earnings and growth.
Inflation and the Stock Market, September 2019 – September 2024
Today, with the Federal Reserve poised to lower interest rates for the first time since 2019, I think it’s notable that inflation has faded as a prominent worry among investors. Now, everyone seems to be worried about economic growth and the jobs market.
Early September featured market volatility, and there was a sharp -2.1% selloff that closely followed weak manufacturing data. Investors were quick to connect the two. The Institute for Supply Management reported manufacturing PMI at 47.2%, which indicates relatively weak manufacturing activity as more factories reported contractionary activity than not. But the attribution of weak manufacturing data to a one-day equity market selloff is not how markets work, and it would almost certainly not be substantial enough to cause a selloff on its own. That’s because manufacturing commands a relatively small slice of total U.S. economic output, at less than 20%.
The U.S. services sector matters far more, to the tune of generating 72% of U.S. GDP in 2023. Services PMI did not garner many headlines in those early days of September, however, which tells me that investors continue to bias negative news. This is a positive for markets, in my view, as it signals the wall of worry is still holding strong. According to the August Services PMI, 51.5% of businesses reported expansion activity for the month, which was slightly higher than July’s print. Business activity registered at 53.3%, and the New Orders Index expanded to 53%. Few talked about it.
Then there’s the jobs market, which recent data suggests is in a weakening pattern, but not in dire straits. First was the report released by the Labor Department, which indicated it may have overstated job gains by 818,000 (in the 12 months through March). Whereas it was previously assumed that the U.S. economy had added close to 250,000 jobs per month in that period, the figure could potentially be closer to 175,000. Headlines warned the economy was weaker-than-expected.
The August payrolls report didn’t help matters, as job growth in June and July was revised lower by 86,000 jobs, signaling that hiring over the summer was slightly weaker than originally reported. It was also reported that total nonfarm payroll employment increased by 142,000 in August, which while solid was essentially lost in the fray of downward revisions.
In my view, the wall of worry is also present here in the storylines about the U.S. jobs market. Even though hiring is slowing from the torrid pace of previous years, there are still new jobs being added at a reasonably solid clip. But headlines make it seem like the economy is cracking and the Fed needs to step in to resuscitate it. That is objectively not the case.
Bottom Line for Investors
At the outset of 2023, investors were worried that inflation had spun fully out of control, and that rising interest rates would choke off growth. A vast majority of economists were predicting a recession.
It never arrived.
Throughout this time, many investors and the financial media focused solely on the inflation story, with every month’s CPI print being framed like it was a make-or-break moment for the market. We can say now, with the benefit of hindsight, that these inflation fears ultimately became the wall of worry that stocks climbed.
I see the same thing happening now with economic growth. Any sign of softer-than-expected data, as we’ve seen with manufacturing and jobs, has sent investors into a tizzy of concern that high interest rates are finally taking their toll. Other headlines posit that the artificial intelligence buildout is a bust. Or that the U.S. consumer is tapped out. The list goes on, and for equity investors, that may be good news – it means concerns have shifted from inflation to growth, potentially giving stocks another wall of worry to climb.
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