Weekly Update: Inflation is Running Hot, but the Economy is Strong

Investors seeking to grow their assets over time generally allocate a portion of their assets into the stock market as stocks tend to do very well over the long term.¹ Further, stock investors have generally experienced much better returns in the U.S. versus abroad. For example, an investment in the MSCI All Country World Index ex-U.S. would have gone up over 4x in value since the end of 1994. However, a same-sized investment in the U.S. Index, S&P 500, would have gone up over 22x in value over the same period.²

There are many reasons for this generally related to how fast companies in the U.S. have grown profits versus the rest of the world. However, the metrics that show how attractive or expensive stock investments are, such as the price-to-earnings ratio, are generally telling a story that the U.S. has become expensive relative to the rest of the world. Specifically, the price-to-earnings ratio of the international index (MSCI ex-U.S. from above) is trading at a 37% discount vs that of the S&P 500. This is two standard deviations lower than normal (JP Morgan's Guide to the Markets, Jan 2025, sixth slide P/E ratios and equity returns)³. Further, this trend towards more relatively attractive non-U.S. equity markets began over 15 years ago following the global financial crisis of 2008.³ However, trends like this do not go on forever. While we do not want to guess when this relatively long trend ends, we do feel some stock or equity allocation outside the U.S. makes sense. 

The U.S. equity market bounced back after posting two straight weeks of losses. The S&P 500 benchmark ended the week just below its record closing high (-0.07%). The markets digested various Fed member speeches, most notably from Fed Chairman Jerome Powell, as well as hotter-than-expected inflation data from the Consumer Price Index (CPI), and additional tariff announcements. 

The CPI inflation report showed a much higher-than-expected jump in consumer prices in January. However, an additional inflation report released the following day pointed to other underlying measures showing a more favorable view of inflation. Specifically, some components that feed directly into the Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures (PCE), came in softer than expected, which ultimately helped reverse the market's reaction to the CPI results.

For the week, the S&P 500 and Dow Jones Industrial rose 1.5% and 0.5%, while the tech-heavy Nasdaq Composite gained 2.6%, and the Russell 2000 was flat.

Changes in Consumer Prices

Key Statistics include:

• Headline CPI rose 0.5% for the month, versus the 0.3% expected.
• Headline CPI rose 3.0% year-over-year, versus the 2.9% expected and an uptick from December’s 2.9% rise. 
• Core CPI rose 0.4% for the month, versus the 0.3% expected.
• Core CPI rose 3.3% year-over-year, versus the 3.1% expected, and an uptick from December’s 3.2% rise.  

The CPI report showed inflation accelerated more than anticipated at the start of the year, likely providing more incentive for the Federal Reserve to continue holding rates steady, especially as the committee has expressed its intent to “wait and see”. This report marks the fourth straight month of rising inflation. 

Headline inflation rose 0.5% in January, bringing the annual inflation rate to 3.0%, both higher than expected and above the Fed’s long-term target of 2.0%. The respective estimates were 0.3% and 2.9%.

The core rate, which excludes the more volatile categories of food and energy and is considered a better predictor of future prices, rose 0.4% for the month and 3.3% from a year ago, both also above forecasts. The respective estimates were 0.3% and 3.1%.

Shelter continues to be a concern for inflation and the main driver of “core” inflation. Higher mortgage rates have pushed consumers into the rental market in which vacancies are near historic lows, causing elevated prices. Shelter which accounts for one-third of the weighting for the overall index rose 0.4% for the month and 4.4% over the past year, contributing nearly 30% of the overall monthly move. 

Food was also another contributing category. The food index increased 0.4% over the month, largely driven by sky-rocketing egg prices. Egg prices have risen 15.2% between December and January as ongoing problems with avian bird flu have forced many farmers to eliminate millions of chickens that would normally be producing eggs otherwise. This is the largest increase in egg prices since June 2015 and accounted for nearly two-thirds of the rise in “food-at-home” prices. 

The CPI report initially spooked investors, with stocks down and bond yields higher on Wednesday morning although regained some of the losses back towards the end of the day. 

The report came a day after Fed Chairman Jerome Powell told members of the Senate Bank Committee that the Fed is not in a hurry to adjust (lower) its stance on policy. Powell acknowledged, “If the economy remains strong and inflation does not continue to move sustainably towards 2%, we can maintain policy restraint for longer.”⁴ It appears the central bank is waiting to evaluate the progress of its current efforts, as well as the impact of tariffs and other uncertainties on inflation. 

Markets largely expect the Fed to proceed with holding the fed funds rate steady for an extended period, pushing back the expectation for a rate cut until the second half of the year.⁵ As always, expectations can change as new data gets absorbed by the markets. 

[1]https://www.nerdwallet.com/article/investing/average-stock-market-return

[2]https://media.ycharts.com/charts/8424154ebf26ef30e4a0ef6316b953db.png

[3] https://am.jpmorgan.com/us/en/asset-management/protected/adv/insights/market-insights/guide-to-the-markets/

[4]Testimony by Chair Powell on the semiannual Monetary Policy Report to the Congress - Federal Reserve Board

[5] CME FedWatch - CME Group

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