Despite a deceleration in core and super core consumer price index (CPI) inflation in April, inflation remains elevated at 0.3% and 0.4% month-over-month, respectively.
Simultaneously, retail sales, excluding autos, gasoline, and building materials, fell by 0.3%, signaling potential consumer fatigue amid dwindling excess savings and a softening labor market, a Roth MKM strategist said in a note on Wednesday.
Even so, “there is no concern in risk markets about the top-line growth implications of slower sales, only jubilation that the worst of the inflationary pressures are in the rearview mirror,” the strategist noted.
This exuberance is evident in the resurgence of speculative behaviors reminiscent of early 2021– with the meme stock darlings GameStop (NYSE:GME) and AMC witnessing substantial gains once again – while expectations for the Federal Reserve to securely “soft land” the business cycle “have risen to shockingly high levels.”
Roth MKM cautions that nominal retail sales are trending at a mere 3% year-over-year, negative in real terms. They point out that a slowing nominal (top-line) economy is vital for the Fed to control inflation, but it will lead to slower revenue growth and pressure on profits unless offset by efficiency gains. Also, there's no evidence of productivity acceleration from the AI frenzy yet.
“There is also little credence given to the negative efficiency ramifications of trade wars, industrial policy, re-shoring and rising political risk, all of which would be productivity headwinds,” the strategist added.
Moreover, they warn against assuming the extended effects of historical liquidity surges, noting that the dominant segments of risk assets are already trading at valuations reminiscent of the spring of 2000.
This environment, coupled with lagging inflationary pressures, complicates the Fed’s path forward. Roth highlights that "risk markets are almost forcing the FOMC into a 'reactive' reaction function," signaling that the Fed may be reluctant to ease monetary policy amid soaring risk asset prices and elevated inflation.
“This, of course, implies more risk to the business cycle than is widely appreciated. We would continue to stick with defensive strategies (rate sensitive and defensive equity positioning e.g., utilities and healthcare),” the strategist concluded.