by Joe Herrle, CFA, CAIA
Vice President
Alternative Assets
Last weekend, as my kids played in the park, a fellow dad struck up a conversation. During our talk, he sighed and asked, "Everything feels so expensive these days, doesn't it?" I’ve heard this sentiment frequently, from friends, family and clients who have expressed curiosity about the rising costs of everyday goods and services. While many individuals are feeling the strain on their finances, inflation measures, such as the Consumer Price Index (CPI), appear to be trending downward, showing a rosier economic picture. So why are people feeling the pinch?
The answer lies in the realm of psychology, specifically something we all experience: anchoring bias. Anchoring bias is our tendency to rely too heavily on the first piece of information we learn when making decisions, and we fail to adjust our choices based on subsequent information. In the case of inflation, the things we buy most frequently, like gas and groceries, often act as our anchors against conflicting data.
Let's analyze this with numerical evidence. From February 2020 to February 2024, gas prices surged 31.9% . . . but the average American only spends about 4.3% of their total budget on gas per the U.S. Bureau of Labor Statistics. Food prices, however, tell a different story. Over that same period, food and beverage prices increased by 22%. Since food accounts for an average of 12-13% of spending, these rising costs are felt more acutely.
Looking at the bigger economic picture, CPI, which tracks a basket of goods and services (including food and gas), shows inflation was up 19% over the same timeframe. That might sound relatively high, but the average hourly wages grew by 21% during that period. In other words, on average, people make more money than before, even after accounting for inflation. Additionally, household net worth has skyrocketed over the past few years, with a reported increase of over 33% from the beginning of 2020 to the end of 2023. So, in reality, most people have more income and wealth than they did pre-pandemic, even if rising gas and grocery bills make it feel otherwise.
Source: U.S. Bureau of Labor Statistics
The anchoring bias can explain this disconnect. Because gas and food are frequent purchases, price hikes are more noticeable in our daily lives. While the overall inflation rate is lower, by comparison, we don't necessarily register the price changes of other things we buy less often.
As for actual inflation, today, PCE inflation, the Fed’s preferred measure of inflation, rose by 2.7% year-over-year, above the 2% target the Fed has targeted. We have stalled on the metaphorical “last mile” of inflation improvement. Yesterday’s annualized GDP reading for March, 1.6% vs. the expected 2.3%, might indicate a cause for concern. After all, high inflation and low growth are the ingredients for everyone's most hated concoction: stagflation. However, we believe that differs from what lies ahead for our economy.
Right now, the underlying inflation-elevated components exhibit “sticky” or persistent characteristics but are not showing signs of reaccelerating. Forward economic indicators give us confidence that a second wave of inflation is not in store. Furthermore, the consumer is strong; the employment rate is incredibly low, wages are rising and household wealth is at all-time highs. Corporate earnings are also high and expected to be strong through year-end.
The main takeaway is that this is not the typical backdrop for a “stagflationary” environment. Despite how inflation or the economic environment might feel, the long-term pattern shows that things are moving in the right direction. There will be bumps on the road, like yesterday's GDP reading, but zooming out to examine the greater trend gives us confidence in equity markets through the end of this year.
Takeaways for the Week
We are in the middle innings of earnings season, as about half of the S&P 500 has reported for the first quarter; reported sales growth has been +4.5% and earnings growth +5.8%
One rate cut by the Fed is now the market consensus for 2024, whereas going into 2024, the market priced in six rate cuts