Earlier this month, on Monday, February 12th, the S&P 500 slid more than 73 points or 1.46%. Inflation expectation was the primary driver. The Federal Reserve Bank (Fed) has successfully tamed the ultra-high inflation. It was able to bring inflation down much faster with much less pain than investors were anticipating. Inflation fell from 6.4% at the start of 2023 to 3.4% in December 2023. Unemployment remained low and capital markets remained healthy. Investors started to believe that the FED could reduce inflation to its 2% target without causing a recession or raising interest rates further. In fact, Fed Funds Futures predicted the Fed would cut interest rates in the second quarter.
January inflation numbers showed core inflation at 3.1%, higher than the 2.9% prediction. However, this inflation was still less than the 3.4% December inflation reading. A single inflation reading should not cause the market to sell-off like it did. January inflation was lower than December inflation but by less than the estimates. Staying invested is likely the best strategy to deal with the increased volatility.
Many economists are anticipating the Fed will start lowering interest rates in June. However, I believe it will only lower rates if the economy slows down, if unemployment spikes, or to prevent a regional bank crisis. If none of these things happen, it will probably keep rates as they are, to preserve options in the future.
S&P 500 (SPY) Full Recovery
As of Friday, February 23rd, the S&P 500 (SPY) has fully recovered from the sell-off. In fact, it hit an all-time high of 5,101. Investors have changed from worrying about inflation to buying into the artificial intelligence boom. We may be in the early stages of AI development, which requires new infrastructure. Large technology companies will outlay enormous amounts of capital to build infrastructure similar to that of the internet in the 1990s. Nvidia (NVDA) is in the best position to take advantage of this buildout, as its Graphics Processing Units (GPU) are the most sought-after for machine learning. NVDA invested heavily in its AI-specific platform to strengthen its position in the market. Many competitors are trying to catch up; however, NVDA's market dominance will be hard to beat.
Inflation Wage Growth
While the January CPI report was hotter than expected, a healthy labor market has driven wage growth and, in turn kept real wages, which is defined as nominal wages less inflation, positive. Since the start of 2023, the growth in average hourly earnings for private employees has outpaced the increase in headline CPI (see chart). Our economy has been struggling to increase real wages. Real wage growth should translate into an increase in living standards. I would like to be optimistic that this trend will continue as everyone would benefit.
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