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Could the Baltimore Bridge Collapse Spark A Rebound in Inflation?

April 02, 2024

Could the Baltimore Bridge Collapse Spark A Rebound in Inflation?

Our hearts go out to the victims of the Baltimore bridge collapse yesterday, but I wanted to take a moment to address any potential market impacts from it because one of the stories I heard frequently yesterday was the collapse could impact supply chains and lead to a bounce back in inflation.

 

That’s unlikely for two main reasons. First, Baltimore is the ninth-largest port in the U.S., but it’s very specialized and it’s not large enough to cause a material supply chain disruption that leads to broader inflation. Additionally, much of the port’s major imports are specialized automobiles and that disruption will be partially absorbed by ports in Charleston, Savannah, and New York/New Jersey. Second, there aren’t major energy imports into the port that could lead to an inflationary spike in energy prices.

 

Coal is a major export from the port and that will cause short-term disruptions, and that’s why we saw the coal names down sharply yesterday as Consol and CSX (the rail operator) declined 6.8% and 1.9%, respectively. But while it will take a long time to rebuild the bridge, this isn’t a material negative for either company, and if the declines become extreme they’re likely a buying opportunity.

 

Bottom line, the bridge collapse is both a human tragedy and a short-term negative for some specific companies (Northeastern coal and rails, autos due to delayed imports) but it’s unlikely to alter the outlook for inflation or growth and it’s not enough to disrupt the bullish mantra of 1) Stable growth, 2) Falling inflation, 3) Looming Fed rate cuts and 4) AI enthusiasm.

 

Assessing (and Ranking) Market Risks as We Start Q2  

The S&P 500 rallied more than 10% in Q1 and has gained more than 28% since the Oct. 27 low. That’s a 28% return in five months, or an annualized return of nearly 60%. One doesn’t have to have a lot of experience in the markets to think that type of pace is unsustainable and it’s reasonable for all of us to expect an uptick in volatility sometime over the coming months. That doesn’t mean the rally will end, but it does mean more volatility.

 

So, at the start of this quarter I wanted to provide a brief analysis of the current risks facing the market. To make this as practical as possible, I’m going to rank these risks by:

1) Probability

2) How much damage it could do to the bull market, so we have a reference of what is most likely to happen and how much damage they could do.

 

Most likely but with a marginal impact: Rate cut disappointment (the market expects fewer than three cuts). The Fed will likely cut in June, but if growth stays resilient and price pressures buoyant, they may guide to less than three cuts in 2024. So far, markets have handled rate cut disappointment very well and that likely will continue as long as economic growth stays solid. Likely Market Reaction: A mild pullback (1%-3%).

 

Possible with a moderate impact: AI earnings disappointment. AI Isn’t responsible for this rally (it would have happened anyway) but it is responsible for part of the intensity. AI-related tech company earnings expectations are through the roof. If they prove too good to be true, we will see selling in mega-cap tech and tech-aligned sectors and that will hit markets. It won’t end the bull market or the rally, but it would easily give back a large portion of the YTD gains. Likely Market Reaction: A moderate pullback (5%-10% ish).

 

Unlikely but with a significant impact: Inflation rebounds. If the Fed is wrong and inflation rebounds it will eliminate a major reason for the October-to present rally, because not only will it destroy rate cut expectations, but it’ll also put rate hikes back on the table and now we have a repeat of the mid-1970s. Higher-for-longer rates will dramatically increase the chances of an eventual recession. Higher-for-longer rates and rising hard landing chances will make this market extremely overvalued and a substantial decline is possible. Likely Market Reaction: 10%-15% decline in the S&P 500.

 

Least likely but with the biggest impact: An economic slowdown. I’ve said this consistently and I’m going to keep saying it because a sudden, unexpected slowing of growth is the potential rally killer because it negates any benefit from looming rate cuts, will result in a 4X-5X reduction in the market multiple and hit some of the most overvalued sectors. Positively, economic data remains resilient and that’s no real signal of a looming slowdown. But, if it starts to show up, that is a potentially major problem for markets. Likely Market Reaction: 15%-20% decline or more.

 

The outlook for markets remains positive as we start the second quarter as the bullish mantra of 1) Stable growth, 2) Falling inflation, 3) Impending Fed rate cuts and 4) AI enthusiasm remains in place. But it is important to monitor potential risks because with valuations stretched and sentiment complacent, this market remains vulnerable to a negative shock.


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