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‘Underlying bullish tenor’: U.S. stocks fare surprisingly well as Treasury yields rise after hotter-than-expected inflation, says Morgan Stanley’s Andrew Slimmon

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U.S. stocks were choppy Tuesday in the wake of the consumer-price-index showing inflation rose more than anticipated in January, but the market avoided a big selloff.

After “the CPI number came in a little hotter than expected,” the yield on the two-year Treasury note has climbed to around 4.6%, said Andrew Slimmon, an equity portfolio manager at Morgan Stanley Investment Management, in a phone interview Tuesday. “I’m surprised that it hasn’t had a more negative impact on stocks,” particularly growth equities, he said of the rise in two-year Treasury yields.

While Slimmon thought higher yields would have weighed more on the U.S. stock market in Tuesday’s trading session, he said that overall “I’m not particularly bearish.” That’s partly because he’s not expecting an “economic collapse,” he said, pointing to lagging defensive stocks as a sign of the “underlying bullish tenor” in the market.

The U.S. Bureau of Labor Statistics said Tuesday that the consumer-price index rose 0.5% in January for a year-over-year rate of 6.4%. That’s above the 0.4% rise that economists polled by The Wall Street Journal had forecast for January. Still, the pace of inflation slowed over the past 12 months from a year-over-year rate of 6.5% in December. 

Meanwhile, core data from the consumer-price index, which excludes food and energy prices, also came in above expectations. Core CPI data showed inflation rose 0.4% in January and climbed 5.6% year over year. 

Read: CPI shows U.S. inflation still sticky and slowing grudgingly in January

“I don’t think people know how to digest this,” said Randy Frederick, managing director of trading and derivatives at Charles Schwab, in a phone interview Tuesday. “It feels to me that it’s a very mixed bag overall, and I think that’s why” the market was choppy Tuesday, he said.

Major U.S. stocks benchmarks flipped between gains and losses Tuesday as investors parsed through details of the consumer-price-index report. They closed mixed.

The S&P 500 index
finished about flat with a less than 0.1% decline, while the Dow Jones Industrial Average
fell 0.5% and the technology-heavy Nasdaq Composite
gained 0.6%, according to FactSet data.

“I didn’t think we’d see a rally in the market unless the numbers came in below expectations,” said Frederick. Some investors might have focused more on the month-over-month rise as opposed to year-over-year declines, while digging into the subcomponents of the index, he said.

Andrew Patterson, senior economist at Vanguard Group, said in emailed comments Tuesday on the CPI report that “goods disinflation continues, though the pace has been less rapid than we anticipated and may fade going forward as goods prices such as those for automobiles normalize.” He also said that “service price growth remains elevated, though less so when accounting for the likely fall in shelter prices coming in the latter part of the year.”

Some of the positive sentiment that has emerged in Tuesday’s trading may be tied to the continuing decline in the year–over-rate of inflation, according to Frederick. “That has come down now for seven straight months” to 6.4%, he said, but “that’s still high inflation.”

The CPI report “highlights the work left to be done by the Fed,” according to Patterson. “While inflation is heading in the right direction, there is a long and bumpy road ahead to price stability,” he said.

Meanwhile, the yield on the two-year Treasury note
rose 8.6 basis points to 4.620% Tuesday, while 10-year Treasury yields
increased 4.4 basis points to 3.760%, according to Dow Jones Market Data.

Defensive stocks ‘woefully lagging’

Morgan Stanley’s Slimmon said he “would not be chasing” growth stocks. “We are moving more into inflation-sensitive stocks,” because as much as inflation is coming down, he said, “I think inflation will be more permanent at a higher level than what we have seen in the past.”

In his view, “that will be better for value stocks than high-multiple growth stocks.”

Meanwhile, the Russell 1000 Growth index
finished 0.4% higher Tuesday, while the Russell 1000 Value index
fell 0.3%, FactSet data show.

But defensive stocks have been “woefully lagging” lately, according to Slimmon, pointing to consumer staples and health care as examples. While the S&P 500 has climbed 7.7% so far this year, its consumer-staples sector is down 1.9% and healthcare has fallen more than 2%, according to FactSet data.

Slimmon also pointed to the outperformance of consumer-discretionary stocks so far in 2023, after being “absolutely clobbered” last year.

“That’s a very bullish indicator because in a bad market consumer staples outperforms consumer discretionary,” said Slimmon. He said he likes stocks in the industrials, materials and financial sectors.

While the market is expecting the Fed to raise its benchmark interest rate another quarter of a percentage point in March in an effort to bring down high inflation, he said that stock-market investors are forward-looking. 

“The stock market will not sit around and wait till the Fed says ‘we’re done’” before rallying, said Slimmon. “You can’t just wait until they’re done and then expect that you’re going to get in. It’s going to be too late at that juncture.”

Read: ‘A different animal’: The bear market is ‘over,’ but that doesn’t unleash bulls to send stocks on a 2023 tear, according to Wells Fargo


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