Monthly Outlook - March 2023

Resummary of the month

Stocks fell in February, reversing some of their January gains, as investors' initial optimism for slower rate hikes and a more dovish Fed was tempered by higher-than-expected inflation and economic variables that may indicate inflation will be more stubborn than expected.

Earnings season was a key driver of market returns, where dispersion among companies was extremely high and weak guidance drove many of the old favorites lower. We expect the dispersion to continue, 10-year Treasury yields rose about 40 basis points, as investors digest the possibility of a longer period of rate hikes.

Macro Corner

In our previous monthly report, we mentioned that positive economic data for a couple of months was necessary, but not sufficient to signal a turnaround. Continued deterioration should be expected as the impact of Fed hikes filters through the economy. Inflation is not something we can put a simple end to.

In the February report, CPI was mixed, with the overall number coming in as expected, rising 0.5% month-over-month and 6.4% year-over-year, but not cooling as some expected. Core CPI, one of the key metrics the Fed analyzes, held steady with a 0.4% increase.

In addition to a slightly higher-than-expected CPI, the Producer Price Index (PPI) was well above expectations. Coupled with retail sales rising faster than they have in a couple of years, it appears that the likelihood of lower inflation is slim. In addition to traditional CPI, the Fed's preferred inflation measure, core PCE, accelerated faster than expected at 0.6% in January and 4.7% year over year. Stocks reacted sharply lower.

Why was the inflation report so bad for stocks?

First, an unusually strong jobs report came out in January, implying a higher end state for rates than previously estimated. The Fed prefers the core PCE to the CPI because the CPI is a survey of consumers, while the PCE surveys businesses. The CPI data are also subject to fewer revisions, while the PCE accounts for substitution effects - basically, consumers switch from one thing to another as prices change.