"We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard."
–John F. Kennedy
Sixty-two years ago, President Kennedy uttered those words in a speech given at Rice University. Seven years later in 1969, before that decade ended, Apollo 11 Commander Neil Armstrong and Lunar Module Pilot Buzz Aldrin landed the Eagle at the Sea of Tranquility and marked the first time a human set foot on the moon: the most significant milestone in human space exploration in history.
I recently traveled with my family to the Kennedy Space Center at Cape Canaveral, Florida to tour the facility. If you are ever in that area, I would strongly encourage you to go, especially if you like space/rockets. The highlight for me was the chance to see, up close, the Saturn V rocket used in the Apollo missions lying horizontally, suspended just overhead. At 363 feet tall (58 feet taller than the Statue of Liberty) and thirty-three feet in diameter, it is one of those things you just need to see in person to fully comprehend its awesomeness. The thought that kept going through my mind was of what it must have been like sitting at the top of that thing as it ignites its six million pounds of fuel to catapult you 238,900 miles away from Earth. It is the equivalent of riding an exploding nuclear bomb almost a quarter million miles. And especially when considering how primitive, by today’s standards, the technology was in the 1960s, it gives you a profound appreciation for the bravery of those Apollo astronauts.
I have been reading Walter Isaacson’s biography on Elon Musk and found the SpaceX section particularly interesting. If you have not read it yet, check it out. Musk’s goal (and efforts) to get humans to Mars before this decade is out is an incredible one. It is easy to throw peanuts from the cheap seats and criticize things like launch failures and timeline shortcomings, but setting audacious goals and endeavoring toward accomplishing them is the literal definition of choosing things not because they are easy, but because they are hard. Having covered the satellite and rocket launch industry for three years in the late 1990s before switching to Financials, I can attest better than most to just how difficult and unforgiving that industry is.
Back to the Global Macro Grind ...
Shifting our focus back to the Pale Blue Dot, the outlook for US inflation to retreat to 2% this year is not particularly encouraging. Consider the role the base effects have played in inflation’s path over the past 4-5 quarters. In the last seven months, the two-year comparative base effect for headline CPI has been unchanged at 6.95% (July 2023) and 6.95% (February 2024). Meanwhile, over that 8-month period, Y/Y headline CPI has gone from 3.18% to …. wait for it …. 3.15%. In other words, it has been a near-perfect reflection of the nothingness of the base effect backdrop.
What if we look back further? Let’s consider the first half of 2023. The base effect steepened from 4.20% in December 2022 to 7.23% in June 2023, a blistering steepening of +303bps in six months. What did inflation do during that period? It fell from 6.45% in December 2022 to 2.97% in June 2023, a decline of -348bps. Strikingly similar, no?
I bring this up only to illustrate the forward setup. The base effect for February 2024 was 6.95%. The base effect for February 2025? 4.59%. That is an easing of -236bps. Meanwhile, consensus has inflation slowing to 2.5% by Q3 (a drop of -65bps) of this year. Our estimate has inflation slightly higher by year-end relative to current levels. Based solely on the base effects, which of those seems more likely to you?
To be fair, there are additional important considerations. For example, on the Shelter side, which is 36% of total inflation, the Y/Y Rate of Change has fallen from 8.04% in May 2023 to 5.74% in February 2024, a decline of -230bps. This alone has reduced headline CPI by -0.8% over that period. Total inflation has slowed 0.9% during that period. So, Shelter has been almost entirely responsible for inflation’s decline since May last year.
Based on our 18mo lead/lag model for Shelter, we think Shelter will continue to pull inflation lower for the next 6-8 months, so this will countervail the base effect impact to an extent.
However, another powerful force is also waiting in the wings. Shipping. Shipping costs, due to Geopolitics, have again climbed significantly. Interestingly, these costs tend not to manifest in inflation data until a full year after they show up in shipping rates. We estimate, using the Kansas City Fed Model, that the positive inflection in shipping rates of late-2023/early-2024 will trigger a full-point reversal in CPI beginning in the back half of 2024 and carrying into 2025. In other words, shipping costs will be reducing CPI by -0.5% in June 2024, but by Dec 2024/Jan 2025 will be adding +0.5% to CPI.
Right around that same time, the downward trend in Shelter inflation is likely to have run its course, and Shelter will instead become pro-inflationary to the CPI numbers. Shorter-term, oil remains bullish TREND and has climbed from $70/bbl in December to $80/bbl today.
So, to summarize these dynamics, significantly easing base effects will cause a powerful countervailing upward force against Shelter’s disinflationary backdrop over the next 6-8 months. Later this year, those base effects will continue to exert upward pressure, but without offsetting Shelter disinflation. Meanwhile, shipping costs beginning in the back half of this year, but especially in Q4 and into Q1 of next year will put significant upward pressure on inflation to the tune of a full percentage point increase.
Of course, energy and food price inflection dynamics play out on a shorter duration and could help to either amplify or nullify these upward/downward forces. As I mentioned above, oil prices have risen roughly 15% in the last few months, adding to the pressure.
It is also interesting to note that, of course, right around the time these renewed upward inflationary pressures will be building, we will have an election. That adds a further element of uncertainty in thinking about inflation’s probabilistic path beyond early 2025.
The net of all this is the same conclusion we have been drawing for some time. Higher for longer. That applies both to inflation and to rates, by extension. This is why, when we look at our monthly Quad outlook through January next year, we have a plethora of Quad 2’s (five of them), a number of Quad 3’s (4 of them) and barely any Quad 1’s (one) and Quad 4’s (one). That is not necessarily a terrible thing, however.
Recall that five of the six quarters from mid-year 2020 through Year-End 2021 were Quad 2 and it was generally an incredibly good environment for being long tech, commodities (2021) and more broadly being out on the risk curve. Remember SPACs?
That being said, Quad 3 punctuates and intersperses the broader Quad 2 backdrop. This suggests that 2024 will have a fair amount, and potentially a significant amount of volatility as the environment often transitions back and forth between the two.
Another consideration looking out across the landscape of 2024 is the Financial Wealth Effect, aka Equities. In the last 14 months, the value of the US Total Equity Market Index has risen from $41 Trillion to $54 Trillion. Now, to be fair, in 2022, that index lost -$12 trillion in value, so the recovery of +$13 trillion needs to be weighed in the appropriate context. Nevertheless, +$13 trillion in ~14 months generates a lot of wealth effect across, in particular, the upper slope of the K where just about all of that wealth sits. This is likely to serve as an incremental growth driver this year, beyond what is already in the cards.
Relatedly, the Housing wealth creation has also been extraordinary since the start of the pandemic. Since 2019, home prices have risen by approximately 50% and roughly $17 Trillion in wealth has been created on the Housing side. This wealth creation is far more distributed than equity wealth as the homeownership rate in the US stands at 65.7% as of YE2023. However, there is a catch. The housing wealth created is more difficult to access as the liquidity and rate constraints are different from on the equity side. The same golden handcuffs of 3% mortgage rates that are severely restricting existing home inventory and, by extension, transaction volumes, are serving to also impair access to this wealth creation. If and when mortgage rates do eventually come down, it will unleash a tremendous amount of stimulus as the pent-up housing wealth effect spending will play catch up across a massive range of discretionary consumption categories.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 10yr Yield 4.05-4.27% (bullish)
UST 2yr Yield 4.48-4.68% (bullish)
SPX 5075-5199 (bullish)
NASDAQ 15,901-16,389 (bullish)
RUT 2045-2110 (bullish)
Tech (XLK) 205-213 (bullish)
Insurance (IAK) 110.38-114.97 (bullish)
S&P Momentum (SPMO) 77.30-80.71 (bullish)
VIX 12.78-15.22 (bearish)
USD 102.22-104.01 (bearish)
Oil (WTI) 77.57-80.75 (bullish)
Copper 3.86-4.09 (bullish)
MSFT 402-421 (bullish)
AAPL 163-178 (bearish)
AMZN 171-180 (bullish)
META 481-516 (bullish)
TSLA 160-189 (bearish)
NVDA 815-950 (bullish)
Bitcoin 64,980-74,920 (bullish)
To your continued success and risk management,
Josh Steiner
Managing Director
