Inflation shows teeth

Two measures of inflation came in hotter than expected this week. The Consumer Price Index (CPI) and the Producer Price Index (PPI) both came in above expectations, showing inflation reversing its downward trend, at least for the time being. Core CPI came in at 0.4% month over month and rose to 3.9% year over year. Core PPI came in at 0.6% month over month and 2.6% year over year. Both numbers are still above the Fed’s target of 2%. The Fed’s preferred measure of inflation, PCE, is expected to be released the week after next, but economists have already begun raising their estimates, with some indicating levels not seen in 12 months.

• One month is not by any means a change in the trend
• However, the markets are concerned this will influence the timing of rate cuts
• For months we have voiced our concern that if the economy is stronger than expected, inflation can remain elevated
• If inflation continues to persist, and at worst, accelerates, this could complicate the outlook for the year
• At least one bank already came out with a small probability of rate hikes this year
• Higher rates from here would most likely be negative for risk assets

Rate cut hopes dashed

The aforementioned inflation readings shifted market expectations for the timing and number of rate cuts this year. While the market still anticipates close to six cuts for the year, the timing of those cuts has now moved out later. At the beginning of the year, markets were pricing in a high probability of the first cut in March and almost a certainty in May. Those probabilities today are just 10% and 30%, respectively.

• Despite this, stocks continue to trade at or close to all-time highs
• The yield on the 10-yr bond, however, rose over 20 bps for the week to a recent high level of ~4.3%
• Market participants have become so accustomed to the low-interest rate environment of the last decade that they continue to expect rates to come right back down
• This was proven wrong in 2023 and is starting to show it could be proven wrong again this year
• As mentioned above, if rates remain structurally higher due to elevated inflation, it could mean valuations of risk assets would reprice lower

Shades of 2000 in AI stocks

This week, the stock of little-known Super Micro Computer (SMCI) soared 25% before falling to close the week slightly higher than where it started. At its peak this week, the stock tripled in value in just the first six weeks of the year in hopes of its server and storage solutions playing a large role in the AI space. The company’s market cap has skyrocketed from ~$4bn at the end of 2022 to ~$56bn at its recent peak.

• We have previously drawn analogies of the current AI boom to the first internet bubble
• However, if you look at the leading darling of this current boom, NVDA, the valuation does not feel bubble-like
• Enter SMCI, which, in its recent move, feels a lot more so
• Every bubble is defined by a strong upward trend based on a new market dynamic originally grounded in fundamentals (e.g., NVDA)
• However, the secondary action usually draws in market participants chasing other related stocks to make a quick buck
• The recent move by SMCI seems a lot more like the market activity in AI has moved on to the next stage
• At its peak on Thursday, the stock by itself was responsible for 1% of the Russell 2000 small cap index’s 1.7% year-to-date gain

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