Feelin' Hot.Hot,Hot

Hotter data, like hotter weather, usually comes with a cost. Homeowners firing up their air conditioners and the Fed keeping rates 'higher for longer' achieves the same chilling effect. I was looking for an upside surprise on today's CPI print, and we got one. The surprising strength of the economy, combined with the easing of financial conditions has been a story that has been waiting to bite hard on the Bull's backside. Inflation's low print this cycle may be well above the Fed's hoped-for 2%.

My caution over the past few weeks has been based on the mismatch of the market's expectations for rate cuts and the reality of a stickier inflation backdrop that should negate those expectations. The hottest trades in AI flared off yesterday on the back of the ARM IPO mania. But beware LLM bulls, higher rates are not your friend. That narrative is now driving the market correction for which I have been waiting. But what does it mean in the short run?

Higher food inflation, auto insurance, and shelter costs were the culprits pushing up the data this month. It would have been even higher but for lower gasoline prices. The bullish argument for bond players has been the shelter component that typically lags the slowdown. However, the gasoline market is the most predictable of all the major components. A typical pattern due to the weather/driving season dynamics means that the recent gasoline rally is likely to extend into summer. February is always the low and prices run until the Memorial Day holiday and then again into the late summer.

Gasoline Seasonality

And lapping easy comps is a forgone conclusion later this year. Even if gasoline prices stay flat, they will contribute to a higher inflation bias for most of this year. This shows the 'stickiness' of inflation. But due to low refinery runs this winter, gasoline has been surging lately, a fact that has yet to be reflected in today's hot CPI. A textbook bottom is now in place. The sudden reacceleration is further proof that the economy is stubbornly resilient and immune to the bearish economic forecasts that were permeating Wall Street just three months ago.

U.S. Gasoline Prices

And what of the other contributors to the 'immaculate disinflation' story that generated the six rate-cut consensus that formed recently? With the help of bearish China real estate news, the copper markets have retreated to their lows but now look ready to make a decisive move. With the potential of a post-Chinese New Year recovery, low inventories, and little new production slated for 2025 and beyond, I think the next move will be higher. With no U.S. recession, the EV buildout, and surging GDP growth in the non-China emerging economies like India, the case for copper looks strong this year. My target is for copper to rise eventually to the prices that can incent new supply, currently estimated to be above $6/lb, over the next few years.

Copper Price

So, the disinflationary tailwinds are about to become headwinds. The no-so-soft landing is virtually complete and the coming bounce in PPI, led by energy costs will catch many a complacent investor napping. In the very short term, pushing out the rate cut expectations will hurt cyclical stocks as well as the AI hype stocks. I am willing to make the argument to buy into that weakness, especially financials, small caps, and cyclicals, as a stronger for longer economy helps to broaden out the breadth of this bull market.

How's that for a hot take?

Risk Model: 3/5 - Risk On

There is a latency to the model that shows up in a strong momentum market as we have experienced this year. AAII bullishness is at an extreme and gets reported with a lag. This week's data is likely to show a pull-back in bullishness that may flip the model's status to a sell mode. We shall see on Thursday. Also, this week's data on retail sales and industrial production should help sharpen the debate about rate expectations. Like the weather in Florida, hot data is what I expect!

AAII Bull/Bear Ratio