There is growing evidence that deflation is spreading around the globe.
Deflation is when prices fall. Of course, this can be a good thing… who doesn’t like falling prices?
But the problem is that if prices fall too fast, the economy can fall into a recession. And that’s no good for Wall Street or Main Street.
So, are these deflationary forces spreading to the U.S.? The answer is yes.
However, there’s no need to panic, and I’ll explain why in today’s Market 360. We’ll consider the recent data, as well as take a look at the latest Personal Consumption Expenditures (PCE) data – the Federal Reserve’s preferred inflation measure. I’ll also explain how, if deflation does show up further, it could actually turn out to be a bullish event – and how you can best position yourself to profit.
Global Deflation Rising…
Recently, Chile announced that its consumer prices declined 0.5% in December, which was a much bigger drop than economists anticipated. Economists expected a 0.1% decline.
The December drop also represented the largest monthly drop since 2013. Chile’s annual inflation rate now stands at 3.9%, but given the sharp drop in prices, the Chilean central bank is set to sharply slash rates at the end of January.
However, China has even bigger deflation troubles. The country has been exporting deflation around the world, and it’s not letting up.
China also revealed that consumer prices slipped 0.3% in December, marking the third-straight monthly decline. Economists anticipated a 0.4% dip in December. Wholesale prices also dropped 2.7% in December, which was on the heels of a 3% decline in November.
So, China’s wholesale prices have now declined for 15-straight months! Deflation is unquestionably enveloping the Chinese economy.
The reality is that China will shrink dramatically going forward. This is partly because of that one-baby policy they had. Unless they “pull a Japan” and figure out how to make their society more productive, they are going to really struggle as an economic power.
Signs of Deflation in the U.S.?
Now, it’s one thing to see deflation in other countries. But I have been seeing some concerning signs that deflation is creeping into our economy. So, let’s take a look at the details…
Right now, deflation has only appeared in wholesale prices in the U.S. The Producer Price Index (PPI) dipped 0.1% in December, which was the third-straight monthly decline. PPI is now only up 1% in the past 12 months. Wholesale food costs dropped 0.9% last month, while the prices for goods declined 0.6%. Both are significant drops – and in turn, the PPI came in much lower than expected.
There have also been signs of deflation in the November Personal Consumption Expenditures (PCE) report. As a reminder, the “core” PCE number, which excludes food and energy prices, is the Fed’s preferred inflation measure. Its stated goal is to see this number fall to 2% on an annual basis.
I should note that core PCE has already been at a 1.9% annual pace on a six-month basis. So, the Federal Reserve’s 2% inflation target is firmly within sight.
This brings us to the PCE report for December, which was released on Friday.
The PCE index grew 2.6% in December compared to the prior year. That also matches November’s pace. But the really big news is the core PCE numbers…
Core PCE rose 0.2% in December, up from 0.1% in November. Year-over-year, core PCE grew 2.9%, down from 3.2% in November and below the 3.0% economists had expected. That’s the first time this number has been below 3% since March 2021 – before the Fed began aggressively hiking key interest rates.
This is big news, folks.
With core PCE inflation now running at 1.5% on a three-month annualized basis and at 1.9% on a six-month basis for the second month in a row, we’re squarely on track to reach that 2% target.
What This Means for Investors
Now, given the recent signs of deflation, I’ve been asked what the biggest repercussion is. Personally, I think deflation could actually turn out to be a bullish event – if the Fed reacts appropriately. The reality is the Fed is going to have to seriously consider cutting key interest rates sooner rather than later, especially if the deflationary signs get worse.
But considering that December retail sales rose 0.6% and Treasury yields then meandered higher, some economists don’t anticipate rate cuts until April. The fact is December’s retail sales were the strongest in the past three months and significantly better than economists’ expectations. In other words, the economic data has been too good, and employment data has also been favorable, so I suspect the Fed won’t cut rates until April.
Right now, the CME FedWatch tool projects a 46.2% probability of a rate cut in March. But by May 1, we’re at about 88%.
I still think the Fed will cut key interest rates more than three times ahead of the November presidential election. Personally, I think we could see as many as eight quarter-point cuts this year.
But whether the Fed starts to cut key interest rates in the first quarter or second quarter, the fact is the Fed will cut key interest rates this year – and these cuts will come faster if deflation continues to rear its ugly head.
How to Position Your Portfolio to Profit
When you couple these rate cuts with the strong earnings environment, it will serve as a “one-two punch” to drive the stock market higher this year. Obviously, the faster the Fed cuts key interest rates, the more impressive the stock market will rally this year. So, hopefully, the Fed will cut key interest rates sooner rather than later.
I should add that there’s $8.8 trillion sitting on the sidelines in money market investments and CDs, which I expect to pour into the market as better-than-expected earnings are announced and interest rates start to decline. So, there is plenty of fuel to propel our fundamentally superior Growth Investor stocks dramatically higher in the upcoming weeks and months.
So, as I’ve told my Growth Investor subscribers, I don’t want you to worry. The fourth-quarter earnings announcement season is underway, and many individual stocks are set to step into the spotlight in the upcoming weeks. I still think our Growth Investor stocks will attract a lot of attention in the wake of better-than-expected quarterly results.
With our fundamentally superior growth stocks, we don’t need to panic. We will just sit tight, let earnings come out and drive our stocks higher.
Currently, my Growth Investor stocks are characterized by 14.3% annual sales growth, 166.5% annual earnings growth, an 8.5% earnings surprise and a median fiscal 2024 price-to-earnings ratio of 16.7. So, my Growth Investor stocks are set up for success this earnings season.
In fact, yesterday I added three fundamentally superior stocks in the February issue of Growth Investor. Each stock is forecast to post strong results, and analysts have revised their earnings estimates higher – and I expect each to beat analysts’ estimates and rally on their strong results.
These stocks aren’t slated to report their latest results for another few weeks, so you still have time to jump in before they start firing on all cylinders once their earnings are out.
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Sincerely,
Louis Navellier
