Stocks finished mixed yesterday. The Dow Industrials set a new record high crossing the 27000 barrier for the first time.

On the flip side, the pharmaceutical stocks were lower as they may still have to lower drug prices to calm political pressure.

Away from healthcare, it was a quiet session.  Earnings season remains a week away.  Everyone is skeptical but the bar may have been lowered so far for most companies that exceeding expectations may not be a big hurdle.  Going forward, pressure from a strong dollar will dissipate in the second half of the year. 

Economic data of note did capture investor attention. Weekly jobless claims fell to just 209,000. There seems to be no sign that the labor market is slowing to a level that might threaten our economic recovery.  On the other hand, CPI numbers were a bit elevated.  Core CPI, less food and energy, rose 2.1% year-over-year.  Digging deeper into those numbers, shelter costs rose 3.5%. They comprise 42% of core CPI.  The biggest chunk of that number is what the government refers to as “imputed rent”, a measure of what the monthly occupancy cost of an owned house would be. The government considers the actual cost of a home as an investment, not an expense.  There are costs related to home ownership that are paid monthly including utilities, insurance, cable TV, etc.  But rather than use mortgage payments, which are fixed at the time of purchase for most of us, CPI includes a derived imputed rent that tries to replicate what the homeowner would be paying for his or her home if it was a rental property.   Don’t get too hung up on the details other than to note that housing related costs are running comfortably above the Fed inflation targets of 2% per year.

But with overall core CPI growing at 2.1% that implies that the other 58% of categories that combine with shelter to create the whole pie are delivering much lower inflation.  Indeed, if you do the math, the inflation rate for all core items excluding shelter is about 1.1%. That includes everything from medical expenses, to transportation to travel.

One can argue that there is a shortage of housing both rental properties and homes for sale.  As a result, inflation is real and above desired levels.  But for almost everything else, supply exceeds demand.  Car dealers are loaded with inventories while millennials like to trot around via an Uber.  Apparel prices have been trending down for a few years.  Electronics prices are driven down by technology advancements. Then there is the substitution effect.  If beef prices rise, consumers switch to pork, chicken or fish. 

A lot of the excess supply comes from overseas.  China created excess capacity long ago whether it be for base materials like steel or the capacity to make t-shirts.  Lowering interest rates might help goose demand for industries that rely on credit, like autos, but that isn’t going to change your appetite for going out to dinner.

Along with excess supply, we are learning to millennials in their 20s aren’t exactly the best managers of their own finances.  Between 2008 and 2012, 41% had credit cards.  That percentage is now 52%.  Their severe delinquency rate is over 8%, far higher than for any other age group.  In addition, many are saddled with student debt on top of their credit card debt.  That average interest rate on outstanding credit card balances is 17%.  Once one gets behind, catching up is hard.  Millennial net worth is significantly lower than for prior generations at the same age suggesting why sales of goods from homes to autos may be under continuing pressure.

Oversupply and some weak pockets of demand explain why Fed Chair Jerome Powell was so dovish in his presentations to Congress over the past two days.  The economy is still growing but shows signs of strain without any evidence of rising inflation.  Will one or two cuts do the trick?  Might Mr. Powell push for a 50-basis point cut at the end of July?  We will have to stay tuned.

In the meantime, markets seemed to be happy with his message. We now move on to earnings season where results may not be great but where expectations are extremely low.

Today, Richard Simmons is 71.  Bill Cosby turns 82.

James M. Meyer, CFA 610-260-2220

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