Media pundits are hyperventilating about inflation’s latest uptick because most of these professional yakkers are 1) political partisans; 2) chasing ratings; and 3) economically illiterate. If you make investment decisions based on their opinions, you do so at your peril.

To be sure, recent reports have shown inflation rates exceeding expectations, prompting concerns about the potential impact on Federal Reserve interest rate cuts in 2024.

However, while the latest inflation hiccup might delay rate cuts, it’s essential to recognize that it probably won’t entirely derail them. You also need to understand that the overall trend for inflation is down.

Below, I examine the current economic landscape, delve into the latest inflation readings and their influence on Fed policy, and explore the ramifications of these interrelated trends on various stock sectors that are particularly sensitive to interest rate changes.

Straight talk on inflation…

Since the outbreak of the pandemic in 2020, inflation can be attributed to various factors, notably supply chain disruptions and, to a much lesser extent, pandemic-induced fiscal stimulus. Elevated crude oil prices also have played a major inflationary role.

As 2024 unfolds, supply chains are on the mend, government stimulus has worked its way through the system, and energy prices, although a wild card (as always), have not risen as much as OPEC+ had hoped.

Regardless, COVID was a “black swan” event and in its wake, the economy is not following textbook rules. Inflation won’t come down in a linear fashion.

The Bureau of Labor Statistics (BLS) reported Thursday that the producer price index (PPI), which measures wholesale prices, accelerated at a faster-than-expected pace in February. This reading comes on the heels of Tuesday’s BLS report that the consumer price index (CPI) also was hotter-than-expected in February.

The PPI jumped 0.6% on the month, higher than the 0.3% forecast and after a 0.3% increase in January. Excluding food and energy, core PPI accelerated by 0.3%, compared to the estimate for a 0.2% increase. On a year-over-year basis, headline PPI rose 1.6%, representing the biggest move since September 2023.

Here’s a mitigating factor: The main culprit for inflation’s flare-up this year has been energy. Notably, roughly one-third of the increase in the PPI for February was driven by a 6.8% increase in gasoline prices. This dynamic is unlikely to persist in future reports.

It should also be noted that many companies are raising prices because, amid the widespread perception of elevated inflation, they simply can. This trend should wane, as deflationary forces get stronger.

Also on Thursday, the Commerce Department reported that retail sales rebounded, up 0.6% on the month. The increase reversed a downwardly revised 1.1% dip in January but was still below the consensus estimate for a 0.8% increase. Consumer demand has remained resilient, but not overheated.

The Fed won’t implement rate cuts before mid-year, as Wall Street had originally expected, but it’s important to note that delaying rate cuts does not imply abandoning them altogether. With uncharacteristic clarity, Fed Chief Jerome Powell told Congress last week that rate cuts “can and will begin” this year.

Powell’s assertion stems from the sharp overall decline of inflation since its peak in June 2022 and the “Goldilocks” condition of economic growth. Although inflation continues to experience blips and anomalies along the way, the general trend is downward. So don’t get spooked by the latest inflation numbers.

Sector-by-sector snapshots…

Let’s focus on salient examples of how specific rate-sensitive sectors are likely to be affected by the Fed’s policy decisions this year:

Tech stocks. Tech companies often rely on borrowing to finance their operations, research, and development. Cheaper borrowing costs can reduce their expenses and increase profitability. Lower interest rates make high-growth tech stocks, which may not currently have high earnings, relatively more attractive to investors compared to fixed-income investments like bonds. Lower interest rates can boost consumer spending, leading to increased demand for tech products and services.

Financials. Banks and financial institutions typically benefit from higher interest rates, because they can charge more for loans while offering relatively higher returns on deposits. Therefore, a delay in interest rate cuts may bolster the performance of financial stocks in the short term.

Real Estate. The real estate sector is highly sensitive to interest rate movements, particularly in the residential and commercial property markets. Lower interest rates tend to stimulate demand for mortgages and real estate investments, driving up property prices and bolstering the sector’s performance. Conversely, higher interest rates can dampen demand for real estate by increasing borrowing costs and reducing affordability.

Consumer Discretionary. Companies operating in the consumer discretionary sector may experience mixed effects from changes in interest rates. On one hand, lower borrowing costs can stimulate consumer spending on discretionary items such as retail goods, travel, and entertainment, benefiting companies within this sector. On the other hand, inflationary pressures may erode consumers’ purchasing power, potentially dampening demand for non-essential goods and services.

Consumer staples. Higher interest rates can impact consumer spending patterns by increasing the cost of credit, such as mortgages and car loans. This can lead to reduced disposable income, causing consumers to cut back on non-essential purchases, which could affect the revenues and stock prices of consumer staples companies.

Utilities. This sector provides “essential services.” Utilities stocks are often considered to be bond-like investments due to their stable cash flows and relatively high dividends. When interest rates fall, the yields on bonds and other fixed-income investments also tend to decrease. As a result, investors may shift their investments from bonds to higher-yielding utility stocks. What’s more, lower interest rates reduce the borrowing costs of utilities, which are capital intensive.

The upshot: Despite increasing uncertainty over inflation and Fed policy, it’s still a shrewd move to rotate into sectors that benefit from lower interest rates. Maintaining a well-diversified portfolio across various sectors and asset classes can help mitigate risks associated with sector-specific volatility and interest rate fluctuations. It’s increasingly clear that the laggards of 2023 (e.g., real estate and utilities) are poised to become the leaders of 2024.

In the meantime, investors were rattled by the latest PPI report and the main U.S. stock market indices closed lower on Thursday as follows:

• DJIA: -0.35%
• S&P 500: -0.29%
• NASDAQ: -0.30%
• Russell 2000: -1.96%

The benchmark 10-year U.S. Treasury yield (TNX) spiked by 2.53%, to close at 4.29%. The CBOE Volatility Index (VIX), aka “fear index,” jumped by about 4% to hover above 14.

The stock market is currently trading at high valuations; healthy dips or corrections should be viewed as buying opportunities within your sector rotation strategy.

Editor’s Note: I expect the cryptocurrency market to continue its winning ways in 2024, as the bull market in Bitcoin (BTC) and other crypto assets forges ahead.

Consider this fact: the “blue chip” of crypto, Bitcoin, gained 156% in 2023. This year, BTC and the broader crypto realm are building on those gains.

Every portfolio should have some sort of exposure to crypto. But you need to be informed, to make the right choices. Start receiving our FREE e-letter, Crypto Investing Daily. Click here now!

John Persinos is the editorial director of Investing Daily.

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