Will higher inflation in December affect advisors' 2024 outlooks?

The December inflation report came in slightly hot. So what should financial advisors do if it really catches fire?

Last month’s consumer price index surprised to the upside month-over-month, up 0.3% versus the 0.1% rise in November, and it also came in a tad higher than the Wall Street consensus of 0.2%.

Over the last 12 months, the all-items index increased 3.4% before seasonal adjustment, according to the Bureau of Labor Statistics. In the year-over-year numbers, core CPI also came in a little north of forecast, up 3.9% versus 3.8%, but still less than last month’s increase of 4%.

Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, says the biggest takeaway for investors from the December inflation report is that the Federal Reserve is done raising rates, not the timing or number of cuts. The general belief on Wall Street is that the Fed came into 2024 expecting to cut three times, even though markets were pricing in twice as many in Zaccarelli’s estimation.

“As long as the economy stays out of recession, the market will keep moving higher and we will have a positive 2024, even if the gains aren’t as exuberant as last year,” he said. “But if we do slide into the waiting-for-Godot recession, then the stock market could drop 20% or more, so that is the most important issue, not when or how many times the Fed ends up cutting in during this normalization phase.”

Zaccarelli’s base case is that the economy won't slide into a recession this year because unemployment is too low and consumer spending is keeping the economy going strong. However, for advisors with clients overly worried about a recession, he suggests concentrating on companies with “strong balance sheets, good management teams and the ability to not only get through a recession without damage to their franchise, but that could potentially take market share during a recession and emerge out of a recovery in even better shape than they entered one.”

He cites examples of such companies from his own holdings, including JPMorgan, Microsoft, Apple, and Alphabet.

Zaccarelli also believes the best insurance against inflation can be found in commodities and energy companies.

“By allocating a small portion of our clients’ portfolios to pipelines, commodity producers and energy companies, our clients will have some inherent inflation protection,” he said, highlighting companies from his portfolio including Occidental, Chevron, Kinder Morgan and Archer-Daniels-Midland.

Daniel Lash, certified financial planner at VLP Financial Advisors, sees top-line inflation staying in the 3% to 3.5% range, despite the Fed’s best efforts to bring it closer to 2%. That said, he expects certain sectors of the economy to grow hotter and colder over the course of the year. 

“Preparing portfolios for what may or may not come in the future, in this case inflation, is a game of timing and historical data shows that accurately timing the future consistently over the long term is unattainable,” he said. “So with that knowledge, we stay well diversified in equities and rebalance them as we see large increases or decreases in particular equity sectors to buy at relative lows and sell at relative highs.” 

On the fixed-income side, Lash said that he exited floating-rate and short-term bonds late last year and moved to more intermediate bonds.

With six rate cuts (or 150 basis points) priced in for 2024, coupled with a 3.7% unemployment rate, respectable GDP growth and a healthy 3.2% core personal consumption expenditures, these factors may spark a new bout of inflation, said Phil Kosmala, managing partner at investment consultant Taiko. As a result, he believes the Fed will be forced to hold rates higher for longer, thereby keeping a lid on stocks as well.

“We plan on trimming equities in the first quarter as the Fed walks back aggressive easing priced in the futures market,” Kosmala said. “Secondly, many analysts are shifting to a weak dollar trade in light of the six cuts forecasted. A US recession would force both a rally in the dollar and in longer-duration Treasuries, both of which typically do well during US recessions.”

Brandon Dixon-James, president and wealth manager at Resilient Wealth Management, part of Osaic, sees inflation returning to a “more normal environment” in 2024 thanks to thoughtful Fed policy. 

As for tinkering with his portfolio in response to December’s elevated CPI report, Dixon-James said he stresses to his clients “the importance of having a long-term outlook, and not necessarily reacting to short-term economic environments.”

Finally, Jonathan Swanburg, founder of TSA Wealth Management, foresees inflation figures continuing to fall in coming months despite the December blip, and predicts they will ultimately hover around the Fed's desired levels. 

“I don't expect that we will revisit the extremely high inflation levels we saw coming out of Covid,” Swanburg said. “However, if we are wrong, long term, we believe equities are the best inflation hedge that exists. So, on that side of the portfolio, we don't believe additional hedging is required.”